Absorption Costing Includes Direct and Fixed Manufacturing Costs in Inventory

Steps:

• Identify absorption costing as a method that allocates all manufacturing costs to products.
• Recall that it includes direct materials, direct labor, and both variable and fixed manufacturing overhead.
• Exclude non-manufacturing costs like selling and administrative expenses from inventory valuation.
• Match choices to standard components: assume 1=direct materials/labor, 2=fixed overhead, 3=non-manufacturing costs.

Why A is correct:

• Absorption costing requires including direct costs (1) and fixed manufacturing overhead (2) in inventory per GAAP, as it treats all production costs as product costs.

Why the others are wrong:

• B excludes fixed overhead, violating absorption's full costing rule.
• C omits direct costs, which are essential for product valuation.
• D adds non-manufacturing costs (3), which are period costs not inventoriable.

Not enough information on exact definitions of 1, 2, 3.

Final answer: A