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Absorption accounting is a method of accounting where all the costs of manufacturing, (including fixed, variable and mixed costs) are allocated to the produced units. This method is in contrast to variable (or marginal or direct) costing, which attaches only variable costs to the manufactured output and charges the fixed costs to the accounting period. Another name for absorption accounting is full costing. Absorption accounting causes per unit product costs to be higher than variable costing (see Table 1) and is a generally accepted accounting principle required for external financial reporting as well as U.S. tax returns.

All other costs for a firm are categorized as period costs. For absorption accounting this is primarily selling and administrative expense, whereas variable costing includes the same...