Since all organization produce more than one product and the overhead costs are incurred together and thus the allocation, appropriation and absorption of these overhead costs have to be done most justly. Allocation allocates the overhead costs to the cost centres or units from where these costs are incurred. Appropriation is done on two levels. On the primary level, appropriation is done by dividing overhead costs to both product and service centres on an equal basis. On the secondary level, overhead costs are distributed on arbitrary bases, depending upon either time or usage. Absorption is the absorption of overhead costs to the production cost. To do this, absorption rate is determined using the following formula:
Overhead Recovery Rate = Overhead Costs/ Unit Chose
The advantage of full cost approach is that it is relatively simple to use this approach if the firm can account for its costs easily. This approach also brings stability to the pricing system, thereby allowing the firm to justify their prices to the consumers. Full costs approach also makes it easier to understand the pricing strategy of their competitors. Under the full cost approach, the firm can expect a reasonable rate of recovery for its products.
However, there are certain disadvantages of the full cost approach. ...Show more