What is Full Costing?
Full Costing, also known as Absorption Costing, is a managerial accounting method where all fixed and variable costs are used to compute the total cost per unit. This method includes both direct costs (like materials and labor) and indirect costs (like factory overhead), providing a comprehensive view of the production costs.
What is Variable Costing?
Variable Costing, in contrast, only considers variable costs—expenses that vary directly with the level of production—when calculating the cost per unit. Fixed costs, which remain constant regardless of production volume, are treated as period costs and are not included in the unit cost calculation.
Detailed Comparison: Full Costing vs. Variable Costing
Types of Costs
Fixed Costs in Full Costing
Fixed costs are those that do not change with the level of production, such as rent, salaries, and insurance.
Variable Costs in Variable Costing
Variable costs change with production volume, including raw materials, direct labor, and utility costs.
Special Considerations
Inventory Valuation
In Full Costing, inventory is valued higher because it includes both fixed and variable costs. In Variable Costing, inventory valuation includes only variable costs, leading to lower inventory values on the balance sheet.
Profit Measurement
Full Costing can result in higher profit margins during periods of increasing production because fixed overhead is spread over more units. Variable Costing provides a clearer picture of the contribution margin, useful for internal decision-making processes.
Examples
Full Costing Example
A company produces 1,000 units of a product. The fixed manufacturing costs are $50,000, and the variable costs per unit are $20. The total cost per unit under Full Costing would be:
Variable Costing Example
Using the same data, the cost per unit under Variable Costing would be:
Historical Context
Full Costing has been historically preferred for external financial reporting because it adheres to Generally Accepted Accounting Principles (GAAP). Variable Costing, however, is more often used internally for managerial decision-making and control.
Applicability
When to Use Full Costing
- For external financial reporting
- To comply with GAAP
- When producing financial statements for stakeholders
When to Use Variable Costing
- For internal decision-making and control
- To analyze contribution margins
- During periods of fluctuating production levels
Comparisons
| Attribute | Full Costing | Variable Costing |
|---|---|---|
| Cost Inclusion | Fixed and Variable Costs | Variable Costs Only |
| Inventory Valuation | Higher | Lower |
| Profit Measurement | Can increase with production | Reflects true variable cost |
| Preference | External Reporting (GAAP) | Internal Management |
Related Terms
- Direct Costs: Costs that can be directly attributed to the production of goods, such as raw materials and labor.
- Indirect Costs: Costs that cannot be directly linked to a specific product, such as utilities and rent.
- Contribution Margin: The difference between sales revenue and variable costs, indicating the portion of sales that covers fixed costs and generates profit.
FAQs
Q: Is Full Costing mandatory for financial reporting?
Q: Can a company use both Full and Variable Costing?
Q: Which costing method provides a better profit analysis?
References
- Horngren, C. T., Datar, S. M., Rajan, M. V. (2012). Cost Accounting: A Managerial Emphasis. Pearson.
- Kaplan, R. S., & Atkinson, A. A. (1998). Advanced Management Accounting. Prentice Hall.
Summary
Understanding the differences between Full Costing and Variable Costing is crucial for both financial reporting and internal decision-making. Full Costing includes all fixed and variable costs, aligning with GAAP for external reporting, while Variable Costing offers insights into contribution margins for internal use. By mastering these accounting methods, managers can make more informed financial decisions and improve business operations.
