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Full Costing



Definition

Full Costing, also known as Absorption Costing, is an accounting method that considers all direct costs and overhead costs associated with the production of a product. Direct costs include direct labor and direct materials, while overhead costs cover indirect expenses such as administration and marketing. The goal is to measure and include all costs to produce and sell a product, thereby providing a complete picture of a product’s profitability.

Phonetic

The phonetics of the keyword “Full Costing” are:Full: /fʊl/Costing: /ˈkɔːstɪŋ/

Key Takeaways

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  1. Full costing, also known as absorption costing, is a method used in managerial and financial accounting that describes the process through which all direct and indirect costs associated with producing a particular product are incorporated in its total cost.
  2. In full costing, both variable and fixed manufacturing costs – such as direct materials, direct labor, and both variable and fixed manufacturing overhead – are included in the cost of a product. It gives a comprehensive view of the total cost per unit.
  3. Full costing can provide a more accurate picture of a company’s profitability by fully capturing the costs of production. However, it may not as effectively aid in management decision-making as variable costing because it doesn’t distinguish between fixed and variable costs.

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Importance

Full Costing, also known as Absorption Costing, is a significant concept in business and finance as it provides a comprehensive view of a company’s total production cost. This method includes all direct costs, like raw materials and labor, and all indirect costs, such as overhead costs associated with the manufacturing process. Hence, Full Costing reflects the complete cost of the production process, providing a clear picture of each product’s profitability. This information supports decision-making regarding pricing strategies, cost control, profitability analysis, and budget planning, thereby playing a crucial role in a company’s operational efficiency, financial performance, and strategic planning.

Explanation

The purpose of full costing or absorption costing, as it’s also known, is to provide a comprehensive view of the total costs associated with producing goods or services in a company. It achieves this by considering all costs, including both fixed and variable overheads, direct materials and direct labor involved in production. By taking all these into account, full costing presents an inclusive cost per unit, providing a more accurate reflection of the total amount a company would expend in the production process for each unit. Therefore, it’s a crucial tool businesses use to set selling prices appropriately, ensuring they cover all necessary expenses and attain profit margins. Moreover, full costing is vital when making internal business decisions. Companies utilize it when they’re evaluating the profitability of individual product lines, deciding whether to keep or discontinue a product line, or considering outsourcing production. By incorporating all aspects of production expenditures, full costing can highlight if certain product lines are costlier than projected and are dragging down profits. Knowing true costs through full costing can help managers selectively emphasize profitable operations and reevaluate, adjust, or discontinue less profitable ones, leading to better strategic business planning and enhanced corporate performance overall.

Examples

1. Manufacturing Industry: In the manufacturing industry, full costing is often used to account for all the costs associated with producing a single unit of a product. This includes direct materials and labor costs as well as indirect costs like utilities, rent, and depreciation of equipment. For example, a car manufacturer like Toyota includes not just the costs of metal, parts, and labor in their full costing, but also the cost of running the factory, such as electricity, maintenance and insurance.2. Restaurant Business: Full costing is also applied in the restaurant business where total costs not only include the direct costs of food and labor, but also indirect costs such as rent or mortgage, utilities, marketing, licensing, and insurance. For instance, a restaurant like McDonald’s would consider the cost of ingredients, staff wages, packaging, licenses, advertising, and overhead costs when calculating their full costing.3. Pharmaceutical Companies: Pharmaceutical companies use full costing to determine the total cost of producing a single unit of a medicine. This includes the costs of raw materials, labor, factory overhead, research and development, and marketing costs. For instance, Pfizer will look at the cost of chemical ingredients, lab equipment, clinical trials, packaging, marketing, and more when calculating full costing for producing a drug.In all these examples, the full costing approach provides a more comprehensive view of profitability and financial decisions.

Frequently Asked Questions(FAQ)

What is full costing?

Full costing, also known as absorption costing, is an accounting method where all direct, fixed, and variable costs are used to compute the total cost per unit of a product. It considers all manufacturing costs, including direct materials, direct labor, and both variable and fixed overhead costs.

What does full costing include?

Full costing includes all of the direct costs associated with producing a product, such as material, labor, variable overhead, and fixed overhead.

What is the main advantage of using the full costing method?

The main advantage of using the full costing method is it gives a comprehensive view of the total cost involved in producing a product or service. This can help businesses make more informed and strategic pricing and production decisions.

How is full costing different from variable costing?

The main difference between full costing and variable costing lies in the treatment of fixed overhead costs. Under full costing, fixed overhead costs are allocated to each unit of product. In variable costing, however, fixed overhead costs are treated as period costs and are not assigned to individual units.

Is full costing useful in pricing decisions?

Yes, full costing is incredibly useful in pricing decisions. By having a comprehensive view of the total cost per product unit, businesses can more accurately set prices that cover costs and deliver a satisfactory profit margin.

When is full costing used?

Full costing is primarily used for internal financial reporting and for calculating the cost of producing goods or services. It is also frequently used in inventory valuation and in the calculation of profit and loss.

Can full costing result in higher reported profits?

Yes, in some cases full costing can result in higher reported profits. This is because under full costing, all fixed costs are spread out over all units produced, lowering the cost per unit. In cases of high production volume, this can result in lower per-unit costs and potentially higher profits. However, it’s important to remember that this can also fluctuate if production volumes decrease.

Is full costing applicable for all types of businesses?

Full costing is beneficial for businesses that have significant fixed costs and businesses in the manufacturing sector. However, it may not be as relevant to service-based businesses or companies where direct costs are more variable in nature.

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