Absorption

Variable and fixed manufacturing overhead are allocated to inventory units based on measures of input (e.g. direct labor hours).

Simple implementation and supported by GAAP.

Stores fixed costs in ending inventory and inaccurate product costs.

Variable

Only variable manufacturing overhead is included in inventory costs. Fixed overhead costs are treated as period expenses.

Does not hide fixed overhead costs in ending inventory.

Not supported by GAAP and ignores externalities.

Activity based

Both variable and fixed overhead costs are allocated to inventory based on measures of activity (e.g. set ups, teardowns).

Results in most accurate product costs.

May not be allowed under GAAP and is costly to use.