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Full Costing

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Absorption Costing

Summary of Full Costing. Abstract

 

The Full Costing method or Absorption Costing (AC) is an inventory valuation / costing model that includes all manufacturing costs:


- Direct materials (those materials that become an integral part of a finished product and can be conveniently traced into it)

- Direct labor (those factory labor costs that can be easily traced to individual units of product. Also called touch labor)

- Both variable and fixed manufacturing overhead

in the cost of a unit of product. As a result, under absorption costing, fixed overhead is a product cost until sold.

It is also referred to as the full cost method.


Should Fixed Manufacturing Costs be Included in Inventories?


Advocates of AC say it should, because all of the production costs are needed to create the products. Thus, they have "future economic benefits."

Advocates of Variable Costing argue that in order for a fixed manufacturing cost to be an asset, it has to meet a "future cost avoidance" criteria much the same way as prepaid insurance. In the case of fixed manufacturing costs, they do not meet this criteria because they are incurred each time the production line opens. Thus, they need to be expenses in that period and only variance expenses inventoried.

Problems with AC also include potential manipulations by plant managers, such as increasing production regardless of sales levels to defer costs to the next year, and show a higher current profit for the sake of bonuses and promotions.


Consequences of using AC for Profit calculation


The difference is important for calculating profit when a beginning and ending inventory levels are different:
- If beginning & ending inventory levels are equal: AC profit = variable costing profit;
- If inventory levels are run down over the period: variable costing profit will be higher than AC profit;
- If inventory levels are increased over the period: AC profit will be higher than variable costing profit.
 

Compare with Absorption Costing: Variable Costing  |  Activity Based Costing

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