What is Absorption Pricing?

When a price is set for a product and the price covers all costs, including variable and fixed costs, it is an instance of absorption pricing. Absorption pricing is a pricing method in which all costs (variable and fixed) involved in the production of a commodity are calculated when setting price for the commodity. With regard to GAAP, absorption pricing includes all the expenses necessary for accounting for the production of a commodity. The price set for a product retrieves/recovers all costs involved in its production. The direct costs, indirect costs, fixed costs, variable costs, wages of workers, utility costs and other costs are calculated when using the absorption pricing. This pricing method also guarantees profit

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How is Absorption Pricing Used?

In a nutshell, an absorption pricing is a method that retrieves all the costs involved in the production of a good. It takes into account the total cost (acquisition costs) which is both the direct and indirect cost of manufacturing a product. Absorption pricing sums up the fixed overhead cost while accounting variable costs. When using absorption pricing, acquisition costs are taken into account. Acquisition costs account for a majority of fixed costs related to an item at the end of a period but not all fixed costs are however accounted for. When using cost of absorption, one needs to assign a fixed overhead to all units produced during the period. The inclusion of overhead costs in the calculation of the cost of absorption rendered it unprofitable at additional domestic prices as against variable costs.

Related Topics

• Job Costing vs Process Costing
• Assign Direct Material and Direct Labor to Job
• Assign Manufacturing Overhead Costs to Job
• Assign Overhead Costs to Products
• Plantwide Cost Allocation
• Department Cost Allocation
• Activity-Based Costing
• Weighted-Average Cost of Products
• Production Cost Report
• Fixed, Variable, and Mixed Cost Estimations
• Contribution Margin Income Statement
• Cost-Volume-Profit Analysis
• Margin of Safety
• Contribution Margin per Unit of Constraint
• Absorption Costing vs Variable Costing
• Differential Analysis and Decisions
• Cost Decisions for Joint Products
• Capital Budgeting
• Life Cycle Costing
• The Master Budget
• Activity-Based Budgeting
• Standard Costs
• Imputed Value
• Variance Analysis for Product Costs
• Absorption Pricing
• Price Variance
• Absorption Variance 
• Responsibility Centers
• Comparing Segmented Income
• Using ROI to Evaluate Performance
• Using Residual Income to Evaluate Performance
• Use Economic Value Added to Evaluate Performance
• Transfer Pricing