What’s it: Full costing is a cost accounting technique that considers all the costs of producing a single unit of product, whether fixed or variable overhead. These costs include direct material costs, direct labor costs, and all overhead costs. Another term for full costing is the term absorption costing.
Full costing components
The full costing method takes into account fixed overhead costs. Therefore, the value will be attached to the cost of goods sold for both finished goods and work in progress. This differs from the variable costing method, which only includes variable overhead costs.
Thus, the production cost, according to the full costing method, consists of the following cost elements:
|Raw material costs||xx|
|+ Direct labor costs||xx|
|+ Fixed overhead costs||xx|
|+ Variable overhead costs||xx|
|= Cost of goods sold||xx|
- Raw material and direct labor costs are directly related to the production process. The company can trace it directly to the output. They include staff wages and the cost of any raw materials used.
- Fixed overhead costs don’t change, regardless of the volume of production. An example is the rental of production facilities. The firm must pay for it, even if it does not produce output.
- Variable overhead costs are indirect costs of operating a business. Their value fluctuates with manufacturing activity—for example, the salary of additional workers in the production department.
Those expenses move with the product through the inventory account in full costing accounting until it is sold. The company then recognizes it in the income statement as the cost of goods sold (COGS).
The difference between full costing and variable costing
Variable costing is an alternative to the full costing method—the difference between the two lies in treating fixed overhead costs, such as salaries and building rent.
Under variable costing, firms exclude fixed overhead costs in their production cost calculations. In other words, this method only recognizes costs that contribute directly to the production process. Furthermore, the company charges a fixed overhead during the period it is incurred.
Conversely, under full costing, the company recognizes fixed overhead costs as an expense when goods or services are sold. Thus, these fixed costs will be attached to the product until the product is sold.
The choice of both has a considerable effect on the company’s financial statements.
However, in practice, there is no better method. Some companies find variable costing more effective, while others prefer full costing. The choice of these two costing methods depends on the company’s managerial attitude, behavior, and design regarding the accurate collection and assessment of input costs.
The advantages and disadvantages of the full costing method
Full costing offers several advantages.
First, full costing results in more accurate production costs. The company considers all overhead costs.
Second, the inventory figures are higher. Because it includes fixed costs in calculating production costs, as long as the product has not been sold, the cost is attached to the product. Thus, it results in higher inventory figures.
Third, operating profit and net income were higher. Because it is attached to a product, the firm will recognize fixed overheads in the cost of goods sold only when sold. If it hasn’t been sold, the overhead costs will still be attached to inventory. That results in a higher operating profit figure compared to variable costing. Conversely, under variable costing, the company recognizes overhead costs as operating expenses even though they have not been sold.
The full costing also has several drawbacks.
First, companies find it more difficult to compare the profit of different product lines. Full costing considers all costs, even those not directly related to a particular product line. Because it uses the same production facility to produce multiple product lines, it is difficult for the company to charge fixed overhead costs to each line.
Second, cost-volume-profit analysis is more complicated. Companies cannot accurately calculate the costs and profit of each line. That makes it difficult for companies to determine how much to produce and sell to reach a profitability point and increases operational efficiency for each line.
Third, it makes the selling price higher when the company uses markup pricing. Under the pricing markup, the company adds a profit percentage to the unit cost. Because full costing takes into account all costs, the selling price will be higher than variable costing.