Approaches to Costing: Full, Contribution
Approaches to Costing: Full, Contribution
Definition of Full Costing
- Full costing, also known as absorption costing, is an accounting method where all direct and indirect costs of producing a product are considered.
- It includes both variable costs such as raw materials, direct labour, power used in the production process; and fixed costs like salaries of managerial staff, rent, depreciation, etc.
Calculation of Full Costing
- The total cost per unit is calculated by dividing the sum of all direct and indirect costs by the number of units produced.
- The formula for full costing is: Total Costs (variable + fixed) / Total Units Produced.
Application of Full Costing
- Full costing provides an understanding of the total cost of running the business and can help make informed business decisions.
- It is useful for external reporting and meeting statutory obligations as it provides a comprehensive picture of overall costs.
Limitations of Full Costing
- One major drawback is that full costing may distort the cost of a product as it includes fixed costs, which do not directly relate to the level of output.
- It might not be helpful for short-term decision-making as it does not differentiate between variable and fixed costs.
Definition of Contribution Costing
- Contribution costing, also known as variable or marginal costing, is an approach which considers only variable costs associated with a product.
- It excludes fixed costs or overheads, which are treated as period costs and are not included in the cost of production.
Calculation of Contribution Costing
- The cost of a unit under this approach is the variable cost per unit.
- The formula for contribution costing is: Total Variable Costs / Total Units Produced.
Application of Contribution Costing
- Contribution costing is particularly useful for internal management decisions, such as deciding whether to accept or reject an order.
- It provides insight into the contribution each unit of a product makes towards covering fixed costs and thereby contributing to profits.
Limitations of Contribution Costing
- Contribution costing may provide a misleading picture of profitability in the short-run, as it overlooks the impact of fixed costs.
- It is not acceptable for external financial reporting as it violates the principle of matching costs with revenues.