Full costing definition
/What is Full Costing?
Full costing is used to determine the complete and entire cost of something. The concept is most commonly used for recording the full cost of inventory in the financial statements. This type of costing is required for financial reporting under several accounting frameworks, such as Generally Accepted Accounting Principles and International Financial Reporting Standards, as well as for income tax reporting.
The essential concept behind full costing is to assign all variable costs to a cost object, as well as an allocation of overhead costs. A cost object is anything about which cost information is collected, such as a customer, product, service, store, geographic region, product line, and so on. The costs that are assigned under full costing include the items noted below:
Direct materials. Direct materials include all raw materials, components, and sub-assemblies used in the production of finished goods. If a business is a distributor or retailer, then the merchandise it acquires for sale can be considered a form of direct materials.
Direct labor. Direct labor includes all labor consumed in the production of goods. Stated differently, it is all labor that would not occur if goods were not produced. In a services business, the cost of the labor required to provide services to customers is considered direct labor.
Commissions. Commissions are the payments made to salespeople that are triggered by the sale of goods to a third party. If there is no sale, then there is no commission. There are many variations on commissions, such as overrides, bonuses, and commission splits; all of these variations fall within the commissions classification.
Allocated variable overhead. Allocated variable overhead is all costs consumed in the production process, other than direct materials and direct labor, that vary with the quantity of goods produced. An example is production supplies. This tends to be a relatively small cost category.
Allocated fixed overhead. Allocated fixed overhead is all costs consumed in the production process that do not vary with the quantity of goods produced. Examples of fixed overhead are depreciation, rent, and supervisor salaries.
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Disadvantages of Full Costing
Full costing is less useful from a practical perspective, since managers are more likely to need the incremental cost of something (as in direct costing), or perhaps the amount of bottleneck capacity that a cost object uses (as in throughput analysis). Problems experienced with full costing include the issues noted below:
Price setting problems. If the sales department is required to set product prices above the full cost of a product, the resulting prices may be inordinately high, especially for incremental pricing situations where the company has excess capacity and could realistically set prices just above direct cost levels. This is a particular problem when competitors are pricing based only on their direct costs, which will result in much lower prices.
Fraud problems. Someone could authorize a drastic increase in production, and use full costing to allocate overhead to units that will be stored in inventory, thereby effectively shifting the recognition of overhead expenses into a future period. This is used to create short-term profits.
Allocation problems. By definition, overhead cannot be reliably assigned to cost objects; otherwise, they would be direct costs. Therefore, an overhead allocation method may assign costs to a cost object that are not warranted. This issue can be mitigated with the use of activity-based costing, which is a more precise form of cost allocation.
Labor problems. Full costing is one of the more time-consuming accounting functions, since it involves the tracing of many types of costs to specific cost objects. Doing so on a consistent basis usually calls for the services of a full-time cost accountant. Some companies like to use more streamlined cost allocation methodologies that are somewhat less accurate, but which minimize the amount of allocation work.
Terms Similar to Full Costing
Full costing also known as absorption costing.
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