How to Calculate Net Income Under Absorption Costing
Absorption costing is a widely used method of accounting in many industries. It is a method of accounting that includes all manufacturing costs in the cost of a product. This includes direct materials, direct labor, and both variable and fixed manufacturing overhead costs. The result is a full absorption of all costs into each unit of production. In this article, we will learn how to calculate net income under absorption costing with these easy-to-follow steps.
Step 1: Define Absorption Costing
Absorption costing is a method of accounting that includes all manufacturing costs in the cost of a product. This includes direct materials, direct labor, and both variable and fixed manufacturing overhead costs. The result is a full absorption of all costs into each unit of production.
Step 2: Identify the Components of Absorption Costing
In order to calculate net income under absorption costing, you must first identify the components of absorption costing. These include direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead.
Step 3: Calculate Direct Materials
Direct materials are the raw materials used in the production process. To calculate direct materials, simply add up the cost of all materials used in the production of a product.
Step 4: Calculate Direct Labor
Direct labor is the cost of labor used in the production process. To calculate direct labor, multiply the number of hours worked by the hourly rate.
Step 5: Calculate Variable Manufacturing Overhead
Variable manufacturing overhead includes all manufacturing costs that vary with the level of production. To calculate variable manufacturing overhead, multiply the variable overhead rate by the number of units produced.
Step 6: Calculate Fixed Manufacturing Overhead
Fixed manufacturing overhead includes all manufacturing costs that do not vary with the level of production. To calculate fixed manufacturing overhead, divide the total fixed overhead cost by the number of units produced.
Step 7: Add Up All Components of Absorption Costing
Once you have calculated each component of absorption costing, add them all together to get the total cost of production.
Step 8: Identify the Selling Price of the Product
The selling price of the product is the amount that the product is sold for. This can be found on the company’s financial statements.
Step 9: Calculate the Cost of Goods Sold
To calculate the cost of goods sold, subtract the total cost of production from the selling price of the product.
Step 10: Calculate the Gross Profit
The gross profit is the difference between the selling price of the product and the cost of goods sold. This represents the profit earned before deducting any expenses.
Step 11: Identify the Variable Selling and Administrative Expenses
Variable selling and administrative expenses are costs that vary with the level of sales. Examples include sales commissions and shipping costs.
Step 12: Identify the Fixed Selling and Administrative Expenses
Fixed selling and administrative expenses are costs that do not vary with the level of sales. Examples include rent and salaries.
Step 13: Add Up Both Types of Selling and Administrative Expenses
Once you have identified the variable and fixed selling and administrative expenses, add them together to get the total selling and administrative expenses.
Step 14: Subtract Selling and Administrative Expenses from Gross Profit
To calculate net income under absorption costing, subtract the total selling and administrative expenses from the gross profit.
Step 15: Identify the Amount of Fixed Manufacturing Overhead in Inventory
Under absorption costing, fixed manufacturing overhead is included in the cost of each unit of inventory. To identify the amount of fixed manufacturing overhead in inventory, multiply the fixed overhead rate by the number of units in inventory.
Step 16: Identify the Amount of Fixed Manufacturing Overhead Expensed
The amount of fixed manufacturing overhead expensed is the difference between the total fixed manufacturing overhead and the amount of fixed manufacturing overhead in inventory.
Step 17: Add the Amount of Fixed Manufacturing Overhead Expensed to Selling and Administrative Expenses
To calculate net income under absorption costing, add the amount of fixed manufacturing overhead expensed to the total selling and administrative expenses.
Step 18: Subtract Total Expenses from Gross Profit
To determine the net income under absorption costing, subtract the total expenses (including fixed manufacturing overhead expensed) from the gross profit.
Step 19: Analyze the Results
Once you have calculated net income under absorption costing, analyze the results to determine the profitability of the company.
Step 20: Make Adjustments as Necessary
If the results of net income under absorption costing are not satisfactory, make adjustments to the production process or the pricing strategy to improve profitability.
