Accounting: Counting the cost - Full Costing

Full (absorption) cost - the total amount of resources sacrificied to achieve a particular objective

Uses of full (absorption) cost information are:

- Pricing and output decisions

- Exercising control

- Assessing relative efficiency

- Profit measurement

Where all the units of output are identical, the full cost can be calculated as:

             Total cost of output
Costs per unit  =   Number of units produced

Where units of output are not identical, it is necessary to divide the cost into two categories: direct cost and indirect cost (overheads)

Direct cost - cost that can be identified with specific cost units (i.e. labour of garage mechanic in relation to a particular job)

Indirect cost (overheads) - cost that cannot be directly measured in respect of a particular job (i.e. rent of the garage)

Full (absorption) cost = direct cost + indirect cost

Direct/indirect is not linked to variable/fixed

Indirect cost is difficult to relate to individual cost units - arbitrary bases are used and there is no single correct method

Traditionally, indirect cost is seen as the cost of providing a 'service' to cost units

Direct labour hour basis of applying indirect cost to cost units is the most popular in practice

- Indirect cost (overheads) can be segmented - usually on cost centre basis; each product cost centre has its own overhead recovery rate

- Cost centres are areas, activities or functions for which costs are separately determined

A variation of job costing where each job consists of a number of identical (or near identical) cost units:

Cost per unit  =  Cost of the batch (direct + indirect) / Number of units in the batch 

If the full (absorption) cost is charged as the sales price and things go according to plan, the business will break even

Full cost information is seen by some as not very useful because it can be backward-looking: it includes information irrelevant to decision making, but excludes some relevant information

Activity-based costing - an approach to dealing with overheads (in full costing) that treats all costs as being caused or 'driven' by activities

Advocates argue that it is more relevant to the modern commercial environment than is the traditional approach

Identification of the cost drivers can lead to more relevant indirect cost treatment in full costing

Identification of the cost drivers can also lead to better control of overheads

Critics argue that ABC is time-consuming and expensive to apply - not justified by the possible improvement in the quality of information