Cost Behavior Patterns and Concepts

Eddison Electric Company (EEC) needs to understand its business model’s different
costing methods, advantages, and applications. Therefore, this report analyzes full, variable,
target, life-cycle, and activity-based costing, with a recommendation on the best for EEC to use.
Full Costing
Full costing or absorption costing is an accounting method where all fixed and variable
manufacturing costs are assigned to units of products during financial reporting (Brewer,2020).
Products and services fully absorb manufacturing costs, and non-manufacturing costs are not
assigned to any units of products.
One advantage of absorption costing is that it evens out any volume fluctuations in the
reported cost of goods and profits. As such, absorption costing helps to achieve consistency in
pricing models. The disadvantage is that more accounting work goes into allocating overheads
between finished goods inventory and costs of goods sold. Companies that use absorption
account for only sold units in the COGS line of the income statement.
Variable costing
Variable costing is a managerial accounting method where only variable costs are
assigned to the manufactured units (Brewer,2020). As such, the units do not absorb fixed costs
but are expensed during the accounting period.
The advantage of variable costing is that it is more detailed, and companies can easily tell
contribution margins from variable cost data, which helps in decision-making. The disadvantage
of this method is that it may cause inventory undervaluation because it undervalues finished

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goods and work in progress. Secondly, variable costing is not GAAP compliant and is therefore
inapplicable by EEC.
Target costing
Target costing is used to develop new products and determine the maximum allowable
cost for the new product. Under target costing, a prototype is used to determine whether the
company can make a maximum profit using the formula:
Target costing = projected selling price – desired profit (Brewer,2020).
EEC can only use this method when designing new products. Firms must determine the
anticipated selling price before designing the product (Brewer,2020). The advantage of target
costing is that it is used to assess the viability of new projects. Target costing also helps
companies better plan their sales and revenue forecasting. The major disadvantage of target
costing is that while companies may set targets, they have less control over the market prices.
When market prices become volatile, it is difficult to predict a stable target cost.
Life cycle costing
Life cycle costing is an accounting method where all costs an asset will incur in its useful
life are determined. Such costs include acquisition, installation, maintenance, operational, and
disposition costs less the salvage value.
The advantage of life cycle costing is that it helps companies plan better for the maintenance of
their assets, and this helps to improve asset efficiency. The disadvantage of life cycle costing is
that it is only applicable for assets and during their useful life.
Activity-based costing

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Activity-based costing is a method for assigning indirect costs and overheads to activities
(Kumar & Mahto, 2013). There are many categories of activities, such as unit-level, batch-level,
product-level, customer-level, and organization-sustaining activities (Brewer,2020). Activity-
based costing is accurate and thus improves the quality of decision-making for managers. The
major disadvantage of activity-based costing is that it is time-consuming since each activity is
evaluated differently (Kumar & Mahto, 2013). Additionally, ABC is not GAAP compliant and is
inapplicable by EEC.
From the above analysis, EEC should use the full costing method. This method is GAAP
compliant and can be used for internal and external reporting. It is easy to use and fits within
EEC’s activity scope.

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References

Brewer, R.H.G.E.N. P. (2020). Managerial Accounting (17th ed.). McGraw-Hill Higher
Education (US). https://coloradotech.vitalsource.com/books/9781260709568
Kumar, N., & Mahto, D. G. (2013). Current trends of application of activity based costing
(ABC): A review. Global Journal of Management and Business Research Accounting
and Auditing, 13(3).