Full costing is an accounting method used to determine the complete end-to-end cost of producing products or services. This approach accounts for all costs, both fixed and variable, as well as overhead, that contribute to a finished product.
Key Takeaways
- Full costing, also known as absorption costing, encompasses all expenses related to production.
- It offers greater transparency and compliance with reporting rules.
- The method may skew profitability in financial statements and complicate cost variation analysis.
Understanding Full Costing
Often termed “full costs” or “absorption costing,” full costing is required by most accounting methodologies, including generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS).
Using this method, all direct, fixed and variable overhead costs are assigned to the end product:
- Direct costs: Expenses directly tied to the manufacturing process, including staff wages, raw materials, and overhead expenses.
- Fixed costs: Overhead expenses such as salaries and building leases that remain constant regardless of production levels.
- Variable overhead costs: Indirect expenses fluctuating with manufacturing activity, like temporary staffing during peak production periods.
In full costing accounting, these various expenses follow the product (or service) through inventory accounts until the product is sold. They are then recognized as expenses under costs of goods sold (COGS) in the income statement.
Full Costing Vs. Variable Costing
Variable costing, also known as direct costing, differs mainly in its treatment of fixed manufacturing overhead costs.
Organizations using variable costing separate operating expenses from production costs. Under this method, fixed manufacturing overhead costs are expensed in the period incurred. In contrast, full costing recognizes these costs upon the sale of goods or services.
Choosing one method over the other can have substantial effects on the financial statements reported. Companies may prefer one approach based on managerial strategy, accuracy in team behavior, and organizational design.
With streamlined production procedures like just-in-time (JIT) becoming more popular, the significance of costs tied to production processes diminishes under both costing methods.
Advantages of Full Costing
Compliance with Reporting Rules: Full costing complies with GAAP, and companies must use this method for external financial statements and tax calculations.
Accounts for All Production Costs: This method provides a comprehensive view of production expenses, aiding in more accurate pricing strategies.
Easier to Track Profits: Full costing offers a clearer picture of profitability when products are sold across different accounting periods, especially during anticipated sales seasons.
Disadvantages of Full Costing
Difficult to Compare Product Lines: Considering all expenses can obscure the profitability comparisons between different product lines.
Impacts Operational Efficiency Analysis: Full costing complicates cost-volume-profit analysis, which affects the understanding of varying costs across different production levels.
Can Skew Profit Evaluations: By delaying the deduction of fixed costs until all products are sold, profitability can appear better than it is during specified periods—potentially misleading investors.
Related Terms: Variable costing, overhead costs, GAAP, IFRS, financial statements, COGS, operating expenses.
