Examining two methods of Full Costing Essay

The construct of full costing is non to look into single costs, for illustration variable costs, but to look at the whole image and all the costs that are associated with accomplishing some aim, i.e. doing a merchandise, or supplying a service. The logic of full costing is that all of the costs of running a peculiar installation, for illustration a edifice, are portion of the cost of the end product of that edifice. For illustration, the rent is a fixed cost that will non change if we merely produce one unit, but if the edifice were non rented so there would be nowhere for production to take topographic point, hence rent is an of import component in the cost of each unit of end product.

‘Full costing: Deducing the entire direct and indirect ( overhead ) cost of prosecuting some activity or aim ‘

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Now we have a sensible apprehension of what full costing entails, we can look at some of the many methods of it. The two most celebrated methods of full costing are Activity Based Costing, otherwise known as ABC, and Absorption Costing. Both of these methods are practiced in concern today, as ways of apportioning operating expenses to associated units of production. Absorption Costing is looked upon as being the more traditional attack, which has been updated with ABC. Both of these methods of full bing have their benefits and drawbacks, which I will look into over the class of this essay. But in order to to the full understand each method, we need to first specify what each one means. Absorption Costing can be defined as,

‘The allotment of specific pools or groups of fixed costs to tie in units of production by a preset per centum or lb sum, based on unit cost, machine or labor hours, or other factors’.A ( hypertext transfer protocol: //www.bridgefieldgroup.com/glos1.htm )

Like any other factor, Absorption Costing has its advantages and disadvantages, for illustration, as mentioned above, it

utilizations predetermined overhead rates to apportion fixed operating expenses to production.A In the long-run, for a concern to do any net incomes, gross revenues must cover all the merchandise ‘s costs.A By including fixed operating expenses in the merchandise ‘s costs, the long-term gross revenues monetary value can be set to cover all costs, including fixed operating expenses. As we can see this is one of the major advantages in Absorption Costing, as it truly stresses the importance of fixed costs. Besides by apportioning costs to the production units, Absorption Costing works out the full production cost for a merchandise. Absorption Costing is thought to be more appropriate for seasonal concern, as it prevents the coverage of false or inaccurate losingss.

Although Absorption Costing is a recognized manner for apportioning costs to production, and is used by many industries today it does hold its drawbacks. The preset rates imply to some directors that a fixed operating expense is a variable cost.A For illustration, if the preset rate for a fixed operating expense is ?5 per direct labour hr, it is possible to reason ( wrongly ) that fixed operating expenses vary with alterations in direct labour hr use. Product lines may be dropped based on this premise even though the merchandises contribute to the overall positive hard currency flow of the house. For this ground it is much harder for direction to understand and construe, and hence can take to blemished determination devising.

Activity Based Costing, the other method of full costing, can be defined as,

‘A technique for more accurately associating operating expenses to specific production or proviso of a service. It is based on credence of the fact that operating expenses do non merely happen but are caused by activities, such as keeping the merchandises in shop which ‘drive ‘ the costs. ‘ ( Accounting: An Introduction, McLaney & A ; Atrill ( 2002 ) Page 559 )

Activity Based Costing is considered to be a more updated and improved version of Absorption Costing, but like Absorption Costing it besides has its drawbacks. Some of the benefits of Activity Based Costing are that it spots those clients, merchandises and sections that are lending the most and least net income to the administration. From this information directors can see countries of strength and failing within the concern and therefore do determinations sing how the concern is handled and organised. From this information directors can besides foretell costs, net incomes and demands associated with alterations in production, construction and costs. ABC to boot tracks the costs of activities and the development of work through the concern, foregrounding countries of high outgo. Directors are able to analyze consequences from ABC and detect the countries that need betterment.

The drawbacks of ABC are besides evident, the whole procedure involved in ABC, i.e. analysis of operating expenses and placing cost drivers is time-consuming and dearly-won. It is argued that the cost and attempt put into this procedure does non outweigh the benefits and so does non warrant transporting it out. ABC is besides criticised about its ability to supply relevant information for directors to transport out decision-making, as the consequences show past costs and non chance costs.

‘Past costs are irrelevant in determination devising and chance costs can be really important, full costing information is an expensive irrelevancy ‘ ( Accounting: An Introduction, McLaney & A ; Atrill ( 2002 ) Page 329 )

Despite the drawbacks and unfavorable judgments of ABC and Absorption Costing, they are widely used in concern today as a agency of apportioning direct and indirect costs to an activity or aim.

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