How does absorption costing differ from variable costing?

Absorption costing is a method that accounts for all manufacturing costs associated with a product, including both variable and fixed manufacturing costs. This means that all costs incurred to produce goods, regardless of whether they fluctuate with production levels (variable costs) or remain constant over a period (fixed costs), are included in the product cost. This comprehensive approach aligns with Generally Accepted Accounting Principles (GAAP) and is crucial for external financial reporting.

By incorporating both types of costs into product costing, absorption costing ensures that the reported inventory value on the balance sheet reflects the total cost of production. This method influences the calculation of net income, especially when inventory levels change, as fixed manufacturing costs are spread across all units produced, impacting the cost assigned to each unit.

The other options do not accurately represent the absorption costing method. For instance, absorption costing does not exclusively include variable manufacturing costs or exclude fixed manufacturing costs as stated in other choices, nor is it irrelevant for inventory valuation, as it is essential for determining the value of inventory and cost of goods sold in financial statements.