Direct Versus Absorption Costing: One Company\u27s Decision

The primary concern of Cost Accounting is to provide Management with information and emphasize planning and controlling of cost. But unlike financial accounting where rigid guidelines are observed, Management has flexibility and determining how best their objectives can be served. This is done by either choosing Direct or Absorption Costing System. The major difference between the systems is the manner in which fixed manufacturing costs are accounted for. Under Absorption Costing, these fixed costs are deferred in inventory until the product is sold while Direct Costing treats them as a period cost and expense in the current accounting period. The Absorption method allows cost allocations of all overhead expenses for the purpose of developing departmental overhead rates which are included in inventory and factored to each cost center. This allows for assigning responsibility to Managers who have little or no control over them and the means to manipulate inventory which can effect inventory. Direct costing does not recognize this allocation procedure. Cost should be accounted for at the source. It is my intention to explore the subject and provide a case study comparing the two accounting methods, implications and analysis of the financial impact. The strength of Direct Costing is that it provides Management more comprehensive and meaningful results. The process of allocation will continue not because of its logic, but because Management is afraid of change and unwilling to explore more viable alternatives