ABSORPTION VARIANCE Meaning and
Definition
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Absorption Variance is a term commonly used in managerial accounting and cost analysis. It refers to the difference between the amount of overhead costs absorbed into the cost of production and the actual overhead costs incurred.
In manufacturing companies, overhead costs are typically categorized into fixed and variable costs. Fixed overhead costs include expenses such as rent, depreciation, and insurance, which are incurred regardless of the level of production. Variable overhead costs, on the other hand, fluctuate in relation to the level of production, such as direct labor, power consumption, and raw material handling.
Absorption variance arises when the overhead costs allocated to each unit of production are different from the actual overhead costs incurred. This can occur due to fluctuations in production volume or changes in the actual costs of overhead items. The difference between allocated and actual overhead costs is known as absorption variance.
Analyzing absorption variance allows managers to assess the efficiency of the company's overhead allocation process. If the variance is positive, it suggests that the overhead costs were overabsorbed, meaning more costs were allocated to production than were actually incurred. Conversely, a negative absorption variance indicates underabsorption, indicating that the allocated costs were lower than the actual costs incurred.
Monitoring and understanding absorption variance is crucial for decision-making as it helps identify potential cost control measures, improve allocation methods, and evaluate the efficiency of production processes. By analyzing absorption variance, companies can make more informed decisions to optimize their costing systems and enhance overall profitability.
Etymology of ABSORPTION VARIANCE
The word "absorption" derives from the Latin word "absorptio", which means "a sucking in".
The word "variance" comes from the Latin word "variantia", which means "a difference" or "a change".
When combined, "absorption variance" refers to the difference or change in the process of absorbing or sucking in.
