What Is Full Costing?

What Is Full Costing?

Let me explain full costing to you directly: it's an accounting method that figures out the total cost of producing your products or services from start to finish. I use this approach to make sure every expense gets accounted for properly.

Key Takeaways

You should know that full costing, which some call absorption costing, covers all costs—fixed, variable, and overhead—that go into making a finished product. One key advantage is it meets reporting requirements and gives you more transparency. On the downside, it might distort profitability in your financial statements and make it tough to spot cost changes at different production volumes.

Understanding Full Costing

You might hear it called 'full costs' or 'absorption costing,' and it's a must in standard accounting systems like GAAP, IFRS, and for tax reporting. When I apply full costing, I assign all direct, fixed, and variable overhead costs right to the final product.

Direct costs are the ones tied straight to manufacturing, like wages for staff, raw materials, and overhead like batteries for machines. Fixed costs are the steady ones, such as salaries and building leases—they don't change no matter how much you produce or sell. Even if your company makes nothing, you still pay that office rent and those wages every month.

Variable overhead costs are the indirect business expenses that shift with production levels. For instance, if output increases, you might hire extra staff, bumping up those variable costs.

In full costing, these expenses travel with the product through your inventory until it's sold. Then, your income statement lists them as cost of goods sold (COGS).

Full Costing Vs. Variable Costing

The main alternative is variable or direct costing, and the big difference is how they handle fixed manufacturing overheads like salaries and leases. With variable costing, companies keep these operating expenses separate from production costs—they focus on just the costs from manufacturing, ignoring daily business running costs.

Under variable costing, you expense fixed overheads in the period they happen. But with full costing, those costs get expensed only when you sell the goods or services. Picking one over the other can really impact your financial statements.

Neither method is inherently right or wrong in practice. It depends on your managerial style, behavior, and how your organization is set up for capturing and valuing costs accurately. As businesses shift to just-in-time (JIT) or streamlined production, full costing might lose some relevance since fewer costs get locked into the process.

Advantages of Full Costing

One major plus is compliance with reporting rules—full costing aligns with GAAP, and even if you use variable costing internally, you have to switch to full costing for external statements and taxes.

It accounts for every production cost, giving you, investors, and management a full view of what it takes to make your products. This helps set the right prices for goods and services.

Tracking profits is easier with full costing, especially if not all products sell in the same period they're made. It's useful when you boost production ahead of seasonal sales spikes, providing a truer profitability picture.

Disadvantages of Full Costing

It can make comparing product lines tricky because it includes expenses not directly tied to production, complicating profitability assessments.

Efforts to improve operational efficiency suffer too—running cost-volume-profit (CVP) analysis gets harder, as you need to figure out how many units to produce and sell to break even. High fixed costs make it tough to see cost variations at different levels.

Finally, it can skew profits by not deducting fixed costs from revenues until everything sells, making your company's profit look better than it is in a given period.