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Full Costing (Full Costing Principle)

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The full costing principle is a very basic approach used by companies to cost products or services. Full costing used for future selling is normally based on budgets for coming company expenditure of direct materials, direct labor cost and indirect overheads. The costing result is then added the desired profit level, which constitutes the selling price used by the sales department.

Of course, the full costing principle is also applicable in the controlling of realized product costs, where actualized costs are allocated to products or services using the same principle as the estimation of the cost price. Besides the direct product costs, such as the material costs, full costing is relying heavily on allocation keys. Allocation keys are basically rules that govern how expected and realized costs must be split to certain cost objects i.e. products, projects, services etc. Allocation keys could be levels of direct material consumption, direct hourly consumption, market specific constraints etc. Common for each allocation key should be that the allocation key is demonstrating a relevant cost driver, meaning that the allocation key must be variable with the cost generation.

Below, examples of allocation keys are presented. The fictive example is both illustrating the budgeted cost of a product in a given period of time, e.g. one reporting month.

Allocation Key based on Hours:

Total Cost for production area / estimated total hour consumption = Hourly Rate

Budget Calculation
$2.500.000 / 10.000 Hours = $250 hourly rate

Actuals Calculation
$2.600.000 / 9.000 Hours = $289 hourly rate

Allocation Key based on direct material consumption

(Total Cost for warehousing area / Estimated direct material consumption) * 100 = Warehouse Overhead %

Budget Calculation
($500.000 / $10.000.000 Total mat. Cost) * 100 = 5% Warehouse Overhead

Actuals Calculation
($600.000 / 8.900.000 Total mat. Cost) * 100 = 6,7 % Warehouse Overhead

Allocation based on market constraints
Total costs for Engineering department / Estimated engineering changes pr. product = Cost pr. engineering change

Budget Calculation
($200.000 / 10.000 changes) = $2 pr. engineering change

Actuals Calculation
($300.000 / 10.000 changes) = $3 pr. engineering change

A costing of a specific product and the corresponsing evaluation of actual costs could look like this.

 

  Budget Cost Budget Cost drivers Budget Rate Actual Cost Actual Cost Drivers Actual Rate
Direct Material Cost $1.000 $1.000 $1.000 $1.010 $1.010 $1.010
Labor Cost $30 1,5 Hours $20 $578 2 hours $289
Warehousing Cost $50 $1.000 5% $6,67 $1.010 6,67%
Engineering Cost $4 2 Changes $2 $12 4 Changes $3
             
Total $1.084     1667,7    
             
Over/Under Absorption       583,7    

Given the levels of cost that the company has actualized in the period, and the individual resource consumption of the individual product, we can see that the actual price of the product is under absorbed compared to the budgetted/estimated price. This will lead to a suffering gross- and net margins, if the selling price of the product is based on the cost estimate.

The biggest weakness of the full costing principle is that it is not working very well with product variability. The problem could be that the allocation keys become too static and incapable of costing the resource absorption of individual products adequately. Products in the same portfolio could potentially have completely different cost structures and consume entirely different levels of overhead costs, even though they might share the same functionalities and core design. An example could be 2 products having the same functionalities but entirely different production set-ups that may vary greatly in costs.

Another costing principle that can potentially cost products more accurately is called Activity Based Costing.
 

 
 
 
 
Date Created: 2014-02-21
Posted by:
 
 
Full Costing (Full Costing Principle)
 

Related resources:

Return on Investment (ROI)
Return on Assets (ROA)
Return on Equity (ROE)
Return on Capital Employed (ROCE)
Contribution Margin and Contribution Margin Ratio
Reference(s)
 
Keywords:

MBA,MsC,Business Learning, Accounting,Full ccost, full costing, costing, budgets, actuals, varaiance analysis, profitability, production order controlling, production controlling, BA, college, Cost Accounting

 






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