Business – 5.4 Costs – Approaches to costing | e-Consult
5.4 Costs – Approaches to costing (1 questions)
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Two major limitations are:
- Distorts cost behaviour analysis: Because fixed overhead is spread over units produced, the method masks the true variable cost of producing an additional unit, making it harder to assess marginal cost and pricing decisions.
- Incentivises over‑production: Since fixed overhead is allocated to each unit, producing more units reduces the fixed cost per unit, which can encourage managers to increase output even when demand does not justify it, potentially leading to excess inventory.