Full costing is an accounting method used by businesses to allocate and assign all direct and indirect costs associated with the production of goods or services. This approach aims to provide a comprehensive and accurate representation of the total cost of producing a product or delivering a service, including both variable and fixed costs. Full costing is also known as absorption costing.

Key components of full costing include:

1. **Direct Costs:**
– Direct costs are those costs that can be directly traced to a specific product or service. In the context of full costing, direct costs typically include direct materials and direct labor. Direct materials are the raw materials directly used in the production process, and direct labor refers to the labor costs directly associated with the production of the product.

2. **Indirect Costs:**
– Indirect costs, also known as overhead costs, are costs that cannot be easily traced to a specific product or service. These costs are incurred for the overall operation of the business and include items such as rent, utilities, depreciation, and indirect labor. In full costing, all indirect costs are allocated to products based on a predetermined overhead rate.

3. **Variable Costs:**
– Variable costs are costs that vary in direct proportion to the level of production or output. In full costing, variable manufacturing costs include direct materials, direct labor, and variable overhead costs.

4. **Fixed Costs:**
– Fixed costs remain constant irrespective of the level of production. Examples of fixed costs include rent for factory space, salaries of permanent staff, and depreciation of machinery. In full costing, fixed manufacturing costs are allocated to products on a per-unit basis.

5. **Absorption of Overhead:**
– One of the key features of full costing is the absorption of overhead costs into the cost of each unit produced. Overhead costs are allocated based on a predetermined overhead rate, often calculated as a percentage of direct labor hours or machine hours.

The formula for calculating the full cost per unit is as follows:

\[ \text{Full Cost per Unit} = \left( \frac{\text{Total Direct Costs} + \text{Total Indirect Costs}}{\text{Number of Units Produced}} \right) \]

Full costing is commonly used for external financial reporting purposes, as it complies with generally accepted accounting principles (GAAP) and provides a more accurate representation of the total cost of production. It is also useful for setting product prices, as it ensures that all costs, including fixed overhead costs, are considered when determining the cost basis for pricing decisions.

However, full costing has some limitations, and alternative costing methods, such as variable costing, may be used for internal management reporting and decision-making. Variable costing only includes variable manufacturing costs (direct materials, direct labor, and variable overhead) in the cost of goods sold, treating fixed manufacturing costs as period expenses.