Question: A light engineering company calculates its production overhead absorption rate at the end of each month by dividing the total actual overheads incurred by the total number of units produced in that month. This blanket absorption rate is then applied retrospectively to the month's production. A variety of products are manufactured by the company and total demand is such that there are some unavoidable seasonal fluctuations in production activity. Production departments vary from light assembly work to semiautomatic machine shops and within each department the processing time for different products varies considerably in some cases products do not pass through every department.
Required: Critically examine the effect of the above system of overhead absorption on the company's product costs, pricing policy and consequent profitability.