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The other is the alteration in the cost structure of companies, undeniably a very important factor affecting the use of this method. In terms of the majority of overhead costs, traditional allocation concepts, based as they are on overhead absorption rates, can often provide misleading information on product costs.

The absorption method
Absorption costing are mostly related to primary activity overhead costs, the major disadvantages of this costing method are connected with overhead department costs. As overhead department costs usually have fixed characteristics, their allocation to a product may cause a distinct growth should installed capacity not be utilized. This means a rise in average fixed costs, with such an output of cost calculation resulting in incorrect decisions being made at managerial level. One potential solution to the problem of allocating fixed overheads is the variable costing method. This is based on allotting variable and fixed costs separately, where fixed costs are not assigned to cost objects. The method is very effective when short-term decisions are required. Some authors have stated that the

variable costing method is a means to providing useful, extra information for decision making (Drury, 2001). Generally, the most important limitations of the variable costing method are defined thus (Kr?, 2006)The construction of the method restricts managers to formulating short-term decisions which could clash with strategic objectives of the enterprises in question;Because fixed costs are not calculated, they are eliminated from consideration; Due to the fact that fixed costs are summarized, the causal relations between costs and objects are lost Consequently, the variable costing process might help managers avoid making inaccurate decisions based on full product costs, but could lead to overhead costs being overlooked. It is often stated by management that they cannot do anything as regards overhead department costs other than generate income to cover them.

Case Study (For Pharmaceutical)

Process Costing

Takes into account continuous process costing, based on an average cost for a quantity produced over a period of time.

Example: A medicine producing plant is continuous the cost of the a medicine can be calculated easily based on historical data, the final packaging may affect the price differently i.e. 100mg tablet will cost more than 500 mg medicine , for the weight of product contained within it.

Example

Calculate the hourly process cost for the following job?

A press operates at 600 units per hour

Capital recovery is over 5 years which amounts to 3000 per year + $30 / hour material cost.

Determine the unit costs of the press based on

80 hours per week

Calculate costs per unit, total costs , total production.

Ans

For 80 hours

Hours worked (48weeks per yr x 5years) x70 per week = 16800 hours

Costs ($30 x 16800) + ($3000 x 5years) = $519,000

Produced units = 16800 x 500 = 10080000

Costs per unit = $435,000 / 10080000 = $0.05148 per unit

In the above example it can be seen the pharmaceutical company practiced process costing for their medicine as it provides the costing of the different processes required to perform