The Conceptual Foundations of Absorption Costing.

Abstract The article presents information on absorption and direct costing. The proponents of absorption costing maintain that in as much as production cannot take place without the incurrence of fixed factory costs, each unit of output must be allocated a pro rata share of those costs. The division of costs into fixed and variable makes sense only in the short run and defined as a situation in which the available quantum of services of at least one factor of production is unalterable while that of at least one other factor can be varied at will. Since the fixed-variable cost dichotomy occupies an important place in both microeconomic theory and cost accounting, it is reasonable to expect a close correspondence between the short-run behavior of costs in theory on the one hand and their accounting treatment on the other. It should be immediately made clear that the definition of the short run advanced above is at variance with the more orthodox definition in an important sense. The traditional cost functions derived from a two-factor production function generally assume that one factor is completely fixed and indivisible but is nevertheless capable of being combined with varying proportions of the other, i.e., variable, factors.