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Pricing - Absorption cost and full cost pricing


If a firm produces a range of products, one accounting issue is how it deals with its fixed/indirect costs, such as rent and interest. This is a subject dealt with in greater detail in the operations and management pack.

Absorption cost and full cost pricing are methods used to allocate all the indirect/fixed costs when determining the price.

  • Full cost pricing is simple, because the same formula is used to allocate all the costs to each of the product. The full-cost pricing formula may, for instance, be based on the area of the factory used to create each product.

S:\TripleA\Design\icons\small\eg.gifFor example, if a product takes up 45% of the factory space, then the firm will allocate 45% of all of the indirect costs (rent, security, interest payments and so on) to that product. The price will therefore be made up of the direct costs per unit, 45% of the indirect costs per unit and a profit mark-up.

  • Absorption pricing is a more sophisticated variant on this where costs are allocated more precisely. Each indirect cost will be treated separately and allocated accordingly.

S:\TripleA\Design\icons\small\eg.gifRent may be allocated according to the factory space used (i.e. the product that takes 45% of the factory space will have 45% of the rent apportioned to it), but other indirect costs may be apportioned differently. Interest payments, however, may be allocated according to the amount of investment in each product. For example, a product where there has been significant investment made in its production, may bear a higher apportionment of the indirect costs than a product where little investment has been made. Marketing costs may also be apportioned according to the products where most marketing effort has been directed.

Advantages and disadvantages of absorption/full cost pricing


  • It recognises the importance of indirect costs as an element of overall cost
  • It allows for more accurate and precise apportionment of costs
  • It offers a more flexible pricing approach than other cost-based pricing approaches


  • It may appear to offer an accurate approach, but in some instances it can be difficult to calculate an accurate apportionment of costs
  • If used in isolation it may focus too much on product and costs and not be sufficiently flexible to take into account changes in demand and customer needs