What is Full Costing
Full costing is an accounting method used to determine the complete end-to-end cost of producing products or services. An example would include recording the full cost of inventory found in financial statements. Its use is required in most common accounting methodologies, including Generally Accepted Accounting Principles, International Financial Reporting Standards, and reporting standards for income tax purposes.
Full costing is also known as "full costs" or "absorption costing."
The alternative to the full costing method is known as variable or direct costing. With the treatment of fixed manufacturing overhead costs being the primary difference between both methods. Under the direct costing method, fixed manufacturing overhead costs are expensed during the period they are incurred. The full costing approach recognizes fixed manufacturing overhead costs as an expense when goods or services are sold. The selection of one method over another can have sizable effects on the reporting of financial statements.
BREAKING DOWN Full Costing
When using the full costing method, all direct costs, fixed, and variable overhead costs are assigned to the end product. These expenses will move with the product (or service) through inventory accounts until the product is sold. The income statement will then recognizes these as expenses under costs of goods sold. Whereas, under direct costing, fixed overhead costs are not assigned to the end product, just direct and variable overhead. Fixed overhead costs are simply expensed during the period they are incurred.
In practice, neither costing method is right or wrong. Some entities will find the variable costing method more effective; others will prefer full costing. The usefulness of method selection boils down to managerial attitude, behavior, and organizational design as it relates to accurate input cost capture and valuation.
As more businesses move to just-in-time (JIT) or related streamlined production procedures and inventory systems, in many ways, direct or full costing methods lose their significance, as fewer costs and expenses are tied up in production processes.
Advantages of full costing include:
- Explicit consideration of fixed costs
- Accurate profit calculation during seasonal sales cycles
- Matches accrual and matching accounting concepts
- Common accounting methodologies (FASB, ASC, ASB) recommend its use
Several limitations of full costing include:
- Fixed period cost vs. future benefit debate
- Arbitrary selection of some overhead costs
- Not entirely useful in managerial decision making