Absorption costing is a comprehensive accounting method used to allocate all production costs, both variable and fixed, to units of output. This approach provides a more holistic view of the total cost of producing a product, incorporating direct materials, direct labor, and overhead costs. In absorption costing, fixed manufacturing overhead costs are absorbed into the cost of each unit produced, resulting in a fuller and more accurate representation of the total expenses associated with manufacturing activities. Components of Absorption Costing: In absorption costing, direct costs such as direct materials and direct labor are explicitly tied to the production of a unit. Simultaneously, indirect costs or overhead, including expenses like factory rent, supervision salaries, and equipment depreciation, are absorbed into the product's cost. This absorption process aims to distribute fixed overhead costs across the units produced, making absorption costing particularly useful for determining product costs for external financial reporting. Impact on Financial Statements: Absorption costing affects financial statements by influencing the reported cost of goods sold and the valuation of ending inventories. Unlike variable costing, which only considers variable production costs in the cost of goods sold, absorption costing includes both variable and fixed manufacturing costs. As a result, absorption costing tends to allocate a higher portion of fixed costs to the cost of goods sold, potentially impacting reported profitability in periods of fluctuating production levels. Question: Considering the impact of absorption costing on reported costs of goods sold and ending inventories, discuss the rationale behind using absorption costing for external financial reporting and how it aligns with the matching principle in accounting. Additionally, what challenges might companies face in applying absorption costing, and how can these challenges be mitigated to ensure accurate financial reporting