Full-Costing Technique, or Absorption Costing, is a method of costing in which all Direct Costs and Indirect Costs (Overheads) are allocated to products, divisions or departments of the business.
Full-Costing Technique is useful for firms as a quick guideline to figure out Total Costs (TC) of the particular product. It is because all costs of the business have been allocated among all the products that the business produces.
First, total Direct Costs for each product need to be calculated. Then, accountants calculate the total Indirect Costs (Overheads) incurred by the business. Finally, they divide, or allocate, those total Indirect Costs (Overheads) between all products, divisions or departments in the firm.
The allocation of Indirect Costs (Overheads) into different products, divisions or departments can be done on the basis of the proportion of total direct labour costs incurred by the products that each account for. Alternatively, Indirect Costs (Overheads) could be apportioned to products on the basis of the proportion of raw materials used in the production of each product.
Example of Full-Costing Technique
The fast-food restaurant sells four different products: hamburgers, hot-dogs, pizzas and sandwiches.
Total cost of direct labor amounts to USD$2,000. Hamburgers account for USD$400 (20%) of this total; hot-dogs account for USD$200 (10%); pizzas account for USD$800 (40%) and sandwiches account for USD$600 (30%).
Total Indirect Costs (Overheads) in this business equal to USD$10,000. If these Indirect Costs (Overheads) are allocated on the basis of the proportion of total labour costs incurred by all four products, then a full-costing statement will look like this:
| Hamburgers | Hot-dogs | Pizzas | Sandwiches | |
|---|---|---|---|---|
DIRECT COSTS | ||||
| DIRECT MATERIALS: | $1,000 | $500 | $2,000 | $500 |
| DIRECT LABOR: | $400 20% | $200 10% | $800 40% | $600 30% |
INDIRECT COSTS (OVERHEADS) = USD$10,000 | ||||
| APPORTIONED OVERHEADS: | $2,000 20% | $1,000 10% | $4,000 40% | $3,000 30% |
| TOTAL COSTS (TC) / FULL COST: | $3,400 | $1,700 | $6,800 | $4,100 |
It is quite obvious now to determine that total cost of making hamburgers is USD$3,400; hot-dogs is USD$1,700; pizzas is USD$6,800 and sandwiches is USD4,100.
After we divide total costs for each product by the Output produced, we will come up with Average Cost (AC) of making each product. This can be useful for setting prices for those four products.
Evaluation of Full-Costing Technique
Full-Costing Technique is particularly suitable to businesses that produce only one product. So, there is no uncertainty whatsoever about what percentage of overheads should be allocated to which product. Single-product firms can freely use this method for making pricing decisions, especially when using mark-up pricing.
For businesses with a larger number of products in their portfolio, Full-Costing Technique is relatively easy to calculate in order to figure out total costs of making each product in the business. By using either the cost of direct labor or the cost of raw materials as a basis for allocating total Indirect Costs (Overheads), it makes the process quite straightforward.
A big benefit of using Full-Costing Technique is that all costs, both Direct Costs and Indirect Costs (Overheads), are allocated between all products and no costs are ignored in the process. In this way, business managers can make comparisons between different products in a particular year, as well as make comparisons of costs calculated on the same basis with costs incurred in previous years.
Therefore, it is advisable that the same basis for allocation is used over time. Otherwise, we will not be able to make meaningful comparisons. If the way of allocating Indirect Costs (Overheads) changes every year, then this could lead to inconsistencies in costs data.
And of course, the biggest issue with Full-Costing Technique is that this method does not apportion overheads on a factual basis. Indirect Costs (Overheads) are not allocated on the basis of real expenditure incurred by the business. We do not know whether the business really spent those USD$2,000 on Indirect Costs (Overheads) related to producing hamburgers. Therefore, this number can be inaccurate or misleading making it dangerous to fully rely on Full-Costing Technique for making final pricing decisions.
Also, in theory, the total costs figure for each product will be true and accurate, only if the business really produces the same output that was used in constructing a full-costing statement. If an oven to bake pizzas breaks down making the restaurant unable to serve pizzas for the whole week, then there will be a fall in both the real direct costs and indirect costs of producing pizzas.
