Full Costing
Definition
Full costing, also known as absorption costing, is an accounting method that assigns all direct and indirect manufacturing costs to the product. This includes direct costs, such as raw materials and labor, as well as a share of indirect costs, including overhead costs like utilities, rent, and administrative expenses. This approach contrasts with direct costing (or variable costing), where only variable costs are assigned to product costs.
Examples
- Manufacturing Company: A car manufacturing company uses full costing to allocate costs. The total cost of producing a car includes the cost of steel (direct material), wages for assembly line workers (direct labor), and a portion of factory rent and administrative salaries (overhead).
- Pharmaceutical Company: A pharmaceutical company producing drugs includes the cost of active pharmaceutical ingredients (direct costs) and incorporates the costs of running the research lab and quality control activities (indirect costs) into the product cost.
Frequently Asked Questions
Q: What are the primary components of full costing?
- Full costing includes direct materials, direct labor, and both variable and fixed manufacturing overhead costs.
Q: How does full costing differ from direct costing?
- Full costing includes all manufacturing costs (both fixed and variable), while direct costing only includes variable manufacturing costs in product costs.
Q: Why might a company prefer full costing?
- Full costing provides a more comprehensive view of product costs and is often required for financial reporting under generally accepted accounting principles (GAAP).
Related Terms with Definitions
- Absorption Costing: Another term for full costing, where all production costs are absorbed by the units produced.
- Direct Costing (Variable Costing): An accounting method where only variable manufacturing costs are considered product costs. Fixed overhead is treated as a period expense.
- Direct Materials: The raw materials that can be directly traced to the production of a specific product.
- Direct Labor: The labor costs that can be directly traced to the production of a specific product.
- Overhead Costs: Indirect costs related to manufacturing that cannot be directly traced to a specific product, such as rent and utilities.
Online References
Suggested Books for Further Studies
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
- “Management and Cost Accounting” by Alnoor Bhimani, Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
- “Cost Accounting: Foundations and Evolutions” by Kinney and Raiborn
Fundamentals of Full Costing: Cost Accounting Basics Quiz
### What is included in full costing?
- [x] Both fixed and variable manufacturing costs
- [ ] Only direct materials
- [ ] Only variable costs
- [ ] Only direct labor costs
> **Explanation:** Full costing includes both fixed and variable manufacturing costs in product cost calculation.
### What is another term for full costing?
- [x] Absorption costing
- [ ] Direct costing
- [ ] Variable costing
- [ ] Semi-variable costing
> **Explanation:** Full costing is also known as absorption costing.
### Under full costing, how are fixed manufacturing overheads treated?
- [x] They are allocated to the cost of the product.
- [ ] They are treated as period costs.
- [ ] They are excluded from product cost.
- [ ] They are deferred and not recognized immediately.
> **Explanation:** Under full costing, fixed manufacturing overheads are allocated to the cost of the product.
### Which of the following accounting principles often mandates the use of full costing?
- [x] Generally Accepted Accounting Principles (GAAP)
- [ ] Cash Accounting Standard
- [ ] Variable Cost Standard
- [ ] Economic Value Added (EVA)
> **Explanation:** Usually, GAAP mandates the use of full costing for financial reporting.
### What does full costing help a company to understand?
- [x] The total production cost including all manufacturing costs.
- [ ] Only the direct costs involved in production.
- [ ] Only the overhead costs.
- [ ] Only the variable costs in production.
> **Explanation:** Full costing helps a company understand the total production cost, including both direct and indirect manufacturing costs.
### In direct costing, how are fixed manufacturing overheads treated?
- [ ] Allocated to product cost
- [x] Treated as period costs
- [ ] Deferred to future periods
- [ ] Excluded from all cost calculations
> **Explanation:** In direct costing, fixed manufacturing overheads are treated as period costs.
### Which cost is an example of a direct cost in full costing?
- [x] Raw materials
- [ ] Factory rent
- [ ] Administrative salaries
- [ ] Property taxes
> **Explanation:** Direct costs in full costing include items like raw materials that can be specifically traced to the production of a product.
### How does full costing affect the costing of unsold inventory?
- [x] It includes a portion of fixed manufacturing overheads in the cost of unsold inventory.
- [ ] It excludes all fixed and variable overhead costs.
- [ ] It only includes direct material costs.
- [ ] It does not affect unsold inventory.
> **Explanation:** Full costing includes a portion of fixed manufacturing overheads in the cost of unsold inventory.
### Which financial statement component is directly affected by the choice between full costing and direct costing?
- [x] Inventory valuation
- [ ] Revenue
- [ ] Cash flows
- [ ] Shareholder equity
> **Explanation:** Inventory valuation is directly impacted by whether full costing or direct costing is used.
### What is one advantage of using full costing for internal decision-making?
- [x] Provides a comprehensive view of total production costs.
- [ ] Simplifies the accounting process by ignoring overheads.
- [ ] Reduces the reported expenses in the income statement.
- [ ] Focuses entirely on variable costs, aiding short-term decisions.
> **Explanation:** Full costing provides a comprehensive view of total production costs, which can be useful for various decision-making purposes.
Thank you for embarking on this journey through our comprehensive discussion on full costing and undertaking our quiz to test your understanding. Keep pushing towards mastery in cost accounting!
