Absorption Pricing – Definition

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Absorption Pricing Definition

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

A Little More on What is Absorption Pricing

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

References for Absorption Pricing

Academic Research for Absorption Pricing

Accounting for decision making and control, Zimmerman, J. L., & Yahya-Zadeh, M. (2011). Issues in Accounting Education, 26(1), 258-259.

Strategic management accounting for pricing: a case example, Simmonds, K. (1982). Accounting and Business Research, 12(47), 206-214.

Product pricing based on accounting costs, Lere, J. C. (1986). Accounting Review, 318-324.

The value of activity-based costing in competitive pricing decisions, Cardinaels, E., Roodhooft, F., & Warlop, L. (2004). Journal of management accounting research, 16(1), 133-148.

The application of management accounting techniques to marketing, Ratnatunga, J., Pike, R., & Hooley, G. J. (1988). Accounting and Business Research, 18(72), 363-370.

The logic of price decision-making, Foxall, G. R. (1980). Management Decision, 18(5), 235-245.

Programming, profit rates and pricing decisions, Colantoni, C. S., Manes, R. P., & Whinston, A. (1969). The Accounting Review, 44(3), 467-481.

The accountant’s contribution to the pricing decision, Sizer, J. (1966). Journal of Management Studies, 3(2), 129-148.

Financial dimensions of marketing management, Kirpalani, V. H., & Shapiro, S. S. (1973). The Journal of Marketing, 40-47.

Use of accounting product-costing systems in making production decisions, Turner, M. J., & Hilton, R. W. (1989). Journal of Accounting Research, 297-312.

 

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