ACCA Applied Knowledge · Management Accounting · Absorption and marginal costing
Which of the following is a limitation of absorption costing?
A limitation of absorption costing is that profit can be raised by producing more than is sold, since some fixed overhead is carried forward in closing inventory. This may encourage overproduction. Marginal costing is the method that excludes fixed overheads from inventory valuation.
- AFixed overheads are not included in product cost, so inventory is undervalued for external reporting
- BProfit can be increased in the short term by producing more than is sold, even if the extra output is not demandedCorrect
- CIt cannot be used to find a selling price that covers full cost
- DIt ignores the production overheads of service departments entirely
Explanation
Under absorption costing, building inventory defers part of fixed overhead to a later period, which raises current profit. This may encourage managers to overproduce. Option A describes marginal costing. Options C and D are incorrect because absorption costing is useful for full cost pricing and allocates service department costs.
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