the differences between full costing and contribution costing

5.4 Costs – Approaches to Costing

Full Costing (Absorption Costing) 📊

Full costing spreads all manufacturing costs – both fixed and variable – over the units produced.

It’s like putting every ingredient into a pizza dough and then slicing the pizza into equal slices. Each slice carries a share of the total cost.

Formula:

\$C_{\text{full}} = \frac{VC + FC}{Q}\$

where \$VC\$ = total variable costs, \$FC\$ = total fixed costs, \$Q\$ = quantity produced.

Example: Produce 100 units, variable cost \$5/unit, fixed cost \$200.

\$C_{\text{full}} = \frac{5\times100 + 200}{100} = \\$7\$\$

Each unit costs $7 when all costs are included.

Contribution Costing (Variable Costing) 💰

Contribution costing includes only variable costs in the cost of a unit. Fixed costs are treated as period costs and are not allocated to individual units. Think of it as only counting the ingredients that change with the number of pizzas you bake.

Formula:

\$C{\text{contrib}} = VC{\text{per unit}}\$

or simply the variable cost per unit.

Example: Same scenario – variable cost $5/unit.

\$C_{\text{contrib}} = \\$5\$\$

Fixed cost $200 is considered a period expense, not part of the unit cost.

Why the Difference Matters? 🧩

  • Decision‑making: Contribution costing shows how each unit sold contributes to covering fixed costs and generating profit.

  • Profit planning: Full costing can inflate unit costs, making it harder to see the real contribution margin.

  • Tax & accounting: Full costing is required for external financial statements; contribution costing is used for internal decision‑making.

Key Comparison Table 📈

Cost ElementFull CostingContribution Costing
Fixed CostsAllocated to each unitPeriod expense, not allocated
Variable CostsAllocated to each unitAllocated to each unit
Unit Cost\$C_{\text{full}}\$ (includes FC)\$C_{\text{contrib}}\$ (only VC)
Profit Contribution per Unit\$P - C_{\text{full}}\$\$P - C_{\text{contrib}}\$

Quick Quiz 🎓

  1. What cost element is *not* allocated to units in contribution costing?

  2. Calculate the contribution margin if price per unit is \$12 and variable cost per unit is \$5.

  3. Why might a company use full costing for its annual report?

Answers: 1️⃣ Fixed costs. 2️⃣ \$12 - \$5 = $7. 3️⃣ Because accounting standards require absorption costing for external reporting.