Full costing is used to determine the complete and entire cost of something, which is most useful for recording it in the financial statements (usually as the cost of inventory). 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.
Thus, the costs that will be assigned under full costing include:
- Direct materials
- Direct labor
- Allocated variable overhead
- Allocated fixed overhead
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:
- Price setting. 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. 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 issues. 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.
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.
Full costing also known as absorption costing.