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....
However, there are certain disadvantages of the full cost approach. The full cost approach does not allow for the adjustment of prices according to the changing demands and competition and thus may result in increased prices of the products against the competition. The full cost approach also does not allow the organization to adapt its pricing structure to prevent loss. This is because the volume of production of the products is not flexible and thus when demand goes down, the volume cannot be suitably adjusted. The treatment of costs in the full cost approach is also standardized and thus do not allow for the differentiation between relevant and irrelevant costs (Lal, 2008) Marginal Costing Approach Marginal Costing has been defined by I.C.M.A London as ‘the ascertainment of marginal costs and of the effect on profits of changes in the volume or the type of output by differentiating between fixed costs and variable costs’ (Murthy and Gurusamy, 2009). Marginal Costing allows the organization to write of its fixed costs in the profit or loss account while using the variable cost to determine the profit margin for the product. The Profit in marginal costing is determined by subtracting the variable and fixed costs from the selling price of the product. By differentiating between fixed and variable costs, marginal costing allows the organization to effectively decide the feasibility of the product by studying the current manufacturing costs. Since the costs are variable, the selling price of the product can also be adjusted to meet the pricing demands of the market. Marginal Costing Approach basically allows flexibility in the management decision, including the make-buy decision, the sales mix and the method of product to be used. Marginal Costing is more
In the Total or Full Cost Approach, the firm calculates all the costs that are to be incurred by the company and adds a profit margin to it. The Full Cost Approach takes into account both the direct and the indirect costs. The pricing of the goods under the total cost approach reflects the actual cost of the product and includes environmental costs…
Contemporary Management Accounting System Table of Contents Overview 3 The Concept of Management Accounting 5 The Drivers for the Changing Role of Management Accounting Practices 7 The Contemporary Business Environment 8 Role of Management Accountants in Contemporary Organizations 10 References 14 Overview Anthony G.
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