Which costing method includes fixed production overheads in inventory valuation?

Which costing method includes fixed production overheads in inventory valuation?

• A. Marginal costing
• B. Absorption costing
• C. Variable costing
• D. Activity-based costing

Answer: (B)

In absorption costing, fixed production overheads are treated as part of the cost of making the goods. This method allocates both variable manufacturing costs and fixed overhead to each unit produced, so the inventory value on the balance sheet includes a share of fixed overhead. The overhead is capitalized with the inventory and only released to the cost of goods sold when the goods are sold, aligning costs with the goods they relate to. By contrast, under variable (marginal) costing, fixed production overheads are considered period costs and are not included in the product cost; they’re expensed in the period incurred, not carried in inventory. Activity-based costing also allocates overhead to products, including fixed overhead, but the standard and most direct answer for including fixed production overheads in inventory valuation is absorption costing.

In absorption costing, fixed production overheads are treated as part of the cost of making the goods. This method allocates both variable manufacturing costs and fixed overhead to each unit produced, so the inventory value on the balance sheet includes a share of fixed overhead. The overhead is capitalized with the inventory and only released to the cost of goods sold when the goods are sold, aligning costs with the goods they relate to.

By contrast, under variable (marginal) costing, fixed production overheads are considered period costs and are not included in the product cost; they’re expensed in the period incurred, not carried in inventory. Activity-based costing also allocates overhead to products, including fixed overhead, but the standard and most direct answer for including fixed production overheads in inventory valuation is absorption costing.