ABSTRACT
The accounting convention in the plant is to allocate the fixed cost to products in proportion to their variable costs. Allocating the same fixed cost to all the products ignores the sales volume and the variable cost incurred in the production and processing of each of the products and just takes account of the number of products in the product mix. In order to determine how the direct revenue can be increased, further data need to be collected, on the capacity requirements per unit of output of each product and on the scope for changing pricing policies, so that trade-off functions between products can then be established, thereby indicating the desirability or otherwise of product substitution. Changes in revenues and direct costs are clearly reflected in the values of the gross margins, but the disadvantage of relying solely on this criterion is that, by ignoring the fixed cost altogether, it alert management to deterioration in profitability when overhead costs rise.
