In financial statements and tax filings the absorption cost approach makes more sense as it does not give management any choice in shifting costs. This affects NPV analysis, though, management is responsible for all costs and this can also lead to analytical problems. For example, factory depreciation costs are not part of production, and many believe, including me, that when looking at product costs, these should not be considered. While they are a part of the business, including these costs will often lead to bad decision making. If a product costs 75 and sells for 90, then all else being equal it should be sold. If we, however, include fixed manufacturing overhead in the cost, the item may seem to have a cost of 100 which is above cost, and so it should not be sold. This would be an error as the administrative overhead would remain as a cost, and we would lose the 15 per unit we could earn to offset this cost.

Thoughts/Questions?