Audit financiar, XIV,study

A comparative Nr. 11(143)/2016, 1253-1263

of the different costing techniques
ISSN: 1583-5812; ISSN on-line: 1844-8801
and their application in the pharmaceutical companies

A comparative Abstract
study of the After its induction in the 19th century, the
pharmaceutical industry covered a long way and now it
became one of the most successful and influential

different industries in the world, with both praise and controversy

on its part. The current study is performed on the
pharmaceutical firms working in the Punjab (Pakistan).
Like the other profit-driven organizations, the main aim

costing of the pharmaceutical firms is to earn the maximum

profit. The profitability also depends on the costing
system. The current paper evaluates the costing

techniques systems, the level of satisfaction regarding the costing

system, the major problems faced during the costing
process and the best method of costing in the
pharmaceutical sector. The questionnaire was designed

and their for the collection of data from 130 pharmaceutical

companies working in the Punjab. For the data analysis,
the descriptive statistics and the graphical method were

application used. The significant result of the study is that most of

the organizations used the marginal costing and many
managers are satisfied with the costing system which
in the pharmaceutical they are using.
Keywords: Pharmaceutical industry, costing system,
companies marginal costing, ABC costing, Punjab.
JEL Classification: M41.

Muhammad ALEEM,
University of the Punjab, Lahore, Pakistan,
E-mail: [email protected]
To cite this article:
Alamdar Hussain KHAN, Aleem, M., Khan, M.H. and Hamad, W. (2016), A comparative
University of the Punjab, Lahore, Pakistan study of the different costing techniques and their application in
the pharmaceutical companies, Audit Financiar, vol. XIV,
Wasim HAMAD, no. 11(143)/2016, pp. 1253-1263, DOI:
University of the Punjab, Lahore, Pakistan 10.20869/AUDITF/2016/143/1253
To link to this article:
.
http://dx.doi.org/10.20869/AUDITF/2016/143/1253

No. 11(143)/2016 1253

 Muhammad ALEEM, Alamdar Hussain KHAN, Wasim HAMAD

like methanol, ethyl acetate, di-chloro ethane and

Introduction methylene chloride, are frequently used to manufacture
The current era is characterized by global competition. the pharmaceutical products in addition to the major raw
This competition forced the manufacturing and services material. The materials for manufacturing the products
firms to become integrated, more flexible and highly are frequently imported (Mushtaq and Chattha, 2008).
automated to increase their productivity by lowering their The pharmaceutical industry is growing in Pakistan.
costs to survive on the market. It is impossible to sustain There is a wide range of pharmaceutical products and
the competitive advantages without having the accurate drugs which are produced and sold by the
system of cost mechanism (Özbayrak et al., 2004). pharmaceutical companies. Now, the pharmaceutical
There are three major systems of costing: companies are playing an important role in the Pakistan
(i) Traditional methods, economy. There are many pharmacy schools which
(ii) Marginal costing methods, and provide quality education to the pharmacy students. The
national profession of Pakistan pharmacists is organized
(iii) ABC costing. as national organizations which control the pharmacy
The current study is about the costing system used by practice in Pakistan and in the Punjab. Punjab’s
pharmaceutical companies. pharmacy council is responsible for conducting the tests
The pharmaceutical companies play a vital role in and examination. However, the current study is about
society, by providing life-saving products to human the costing techniques prevailing in this sector.
beings. Within this perspective, this sector explores the Triest and Elshahat (2007) argue that there is scant
development and discovery of new pharmaceutical research available generally on management practices
products, the secure and quick development of the and especially on the accounting practices in non-
products and finally the production and distribution of developed /non-western countries. The reason is the
these safe and sound products to the end user (Masood lack of knowledge. Parnell and Hatem (1999) stated that
et al., 2009). the work of the expatriate manager is well-managed and
Mushtaq and Chattha (2008) argue that the scope of documented and it is very difficult to apply the western
pharmaceutical manufacturing is three folded: concept in the business environment of non-western
countries. There are lots of studies conducted on the
1. Research and development;
costing techniques in the developed counties, but there
2. To convert the natural and organic substances into is scant research available on the costing techniques in
bulk pharmaceutical ingredients through extraction, Pakistan. In the current era in which costing techniques
chemical synthesis and fermentation; provide accurate results, it has become a significant
3. To manufacture the final pharmaceutical product. problem because different costing techniques provide
different costs and profits for the firms. Similar to the
In Pakistan the first two functions are not performed;
other profit driven organizations, the main purpose of
only the pharmaceutical products are produced here.
pharmaceutical companies is to earn the maximum
There is a wide range of pharmaceutical products and
profit, while the profit can be maximum if there is a
chemical products which are produced by the
proper costing technique for accurate costing. The
pharmaceutical companies; these include disinfectants,
current paper shows and evaluates the costing system
anaesthetics, muscle relaxants, water soluble salts,
used by the pharmaceutical companies in Punjab,
antibiotics, anticlotting agents, antihypertensive
Pakistan. It is based on a survey conducted on the
diuretics, anti-infective, analgesic, vitamins and anti-
pharmaceutical companies which are working in the
depressants. The pharmaceutical sector of Pakistan
Punjab.
devises, packs and fills a diversity of pharmaceutical
products, with unique trade names in the shape of The objectives of the study are to:
tablets, oral powders for suspension, lotions and 1. Identify the costing systems that the pharmaceutical
ointments, capsules, creams, syrups, ampoules and companies are currently using;
injectable substances. Lactose, sugar etc. are also used
2. Assess the degree to which managers are satisfied
to produce the different products by the pharmaceutical
with the different costing techniques;
companies, along with the active raw material. Solvents

1254 AUDIT FINANCIAR, year XIV

A comparative study of the different costing techniques
and their application in the pharmaceutical companies

3. Identify the problems regarding the existing costing The main costing systems can be categorized based on
systems; the product process and the production processes as
4. Assess how indirect costs are charged to the follows (Kaplan, 1984; Cooper and Kaplan, 1988).
product. Product cost. The costing methods concerned with
product costing are:
1. Literature review · Variable/marginal/direct costing;

First of all, we examined the following questions · Full/absorption costing.

regarding the costing system in the pharmaceutical Production process cost. The costing methods
sector: concerned with the production process cost are:
(i) What is meant by cost model? · Process costing;
(ii) What is the significance of this model for the · Job order costing.
pharmaceutical sector? This article is concerned with the product cost and not
(iii) What are the major costing systems? with the production process cost. According to Garrison,
A cost model is used by the companies to have a Noreen and Brewer (2004), in the manufacturing
better understanding regarding the costs, in order to organizations two most common techniques are used for
run their business effectively (Kaplan, 1984). The cost the valuation of the inventory and cost of goods sold.
model performs the following functions: The absorption costing is used commonly for the
external purposes and the marginal costing is used for
(i) The assessment of inventory and cost of goods the internal decision making by the management. The
sold; two techniques provide a different net operating profit,
(ii) The estimation of the cost of products, services, while the difference may be quite high. Garrison, Noreen
customers and activities and Brewer (2004) define the variable and absorption
(iii) The provision of feedback to the manager about costing as below.
the efficiency of the process. The absorption costing considers all the manufacturing
Hatzis et al. (2011) is of the view that the other overhead as part of the product cost, whether it is fixed
purpose of the cost model is to provide useful or variable. In the absorption costing, the per unit cost
information for decision making, after getting and consists of direct raw material, direct labour and both
analysing of the data. The effectiveness of data is fixed and variable overhead. It means that in the
depending on the right information for making the right absorption costing the fixed part of the manufacturing
decision. also becomes a part of the product cost, in addition to
the variable manufacturing cost. Direct material is a
Mehmood et al. (2009) stated that in the current era
primary part of the product and it can be easily
the pharmaceutical sector is becoming a more
traceable in the product (e.g. wood in furniture, hard
multifaceted and dynamic environment. There are a lot
drive in the computer); direct labour can be easily
of changes in this industry, like the amplified buyer
traceable in the product, it is called touch labour (e.g.
cost sensitivity, the new market, the technological
the labour of the carpenter); the manufacturing costs
advancement and the global competition, which has
include all costs which were incurred on manufacturing
increased up to uncertain level. The patient’s
the product, except the direct material and the direct
expectations are higher, the healthcare cost has also
labour (Garrison, Noreen and Brewer, 2004). The
increased and the incapacity of the economy to meet
natural and organic substances become the material
the increased cost is the major challenge for the
for the pharmaceutical companies and the persons
pharmaceutical industry. Like other profit driven
who are directly involved in the production of
industries the main objective of the firm is to maximize
pharmaceutical product become the part of direct
the profit, while the profit is maximum if there is a
labour. There are the following advantages of the
proper procedure for the costing; therefore, the costing
absorption costing (Garrison, Noreen and Brewer,
techniques have a great importance for the
2004):
pharmaceutical sector.

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 Muhammad ALEEM, Alamdar Hussain KHAN, Wasim HAMAD

(i) Fixed cost of manufacturing is also recovered; (vi) Variable costing provides a better prediction of the
(ii) Total cost is recognized; profit, because there is no subjective allocation of
fixed cost.
(iii) It is useful for pricing decisions and perdition of
Gupta and Parmar (2001) argue that marginal costing
profitability; approach should also be conceded along with the
(iv) It is used for external purposes. absorption costing because it represents an effective
In the variable costing, only that part of the cost is way to control the cost. They also state that with the help
considered in the product which varies with the level of of marginal costing we can also observe those
activity. It consists of direct material, direct labour and resources which are unproductive because the attention
is invited to the fixed cost in the marginal costing.
the variable manufacturing overhead cost. Fixed cost is
not considered a part of the product cost in variable Pong and Mitchell (2005) argue that different methods of
costing. The fixed manufacturing cost becomes a part of costing provide different net profits, because of
the period cost, like the administrative and selling differences in the value of stocks. The effect on the profit
expenses, thus in the variable costing the inventory and also depends on the opening and closing stock. If the
cost of goods sold does not consist of any fixed cost of value of the opening and the closing stock is the same,
production. Variable costing has a number of then the profit is the same under marginal and
absorption costing, and if there is no opening and
advantages (Garrison, Noreen and Brewer, 2004):
closing stock, then there is also no difference in the
(i) Data can be taken directly from the variable costing marginal and absorption costing profit. How much profit
for Cost-Volume-Profit (CVP) analysis; however, in is different in both costing techniques is depending on
absorption costing it is not easily available; the following two things:
(ii) Profit is not affected by the change in inventories; · The difference between the absorption and the
(iii) The manager often assumes that the per unit cost is variable cost per unit (level of fixed cost per unit).
the variable cost, but in absorption costing both fixed · The value of the ending and the opening inventory.
and variable costs are treated in per unit cost; Table 1 provides the potential effect of both costing
(iv) In the variable costing, the fixed cost is clearly shown methods on the profit. No method has a complete
in the income statement; in this way we can negative or positive effect on the profit. If we change the
emphasize fixed costs to become truly profitable; costing method, the profit can increase or decrease
depending on the stock adjustment (Pong and Mitchell,
(v) Variable cost profit is close to the net cash flows; 2005).

Table 1. Impact of absorption costing and variable costing on profit

Stock valuation method Increase in stock Decrease in Stock
Marginal costing Low profit High profit
Absorption costing High profit Low profit
Source: Authors’ processing.

A new costing system emerged from the last decade, i.e. department of factory. It is used for the development of
the ABC system. The early concept of this system cost estimation when the project can be divided into
emerged in the sixties and seventies in the USA quantifiable activities, discrete or a work unit (Cooper
(McConville, 1993) by the General electric company, and Kaplan, 1988; Innes, Mitchell, and Sinclair, 2000). It
and in Germany by the Schlafhorst and Siemens means that this activity can be clearly implemented
(Ziegler, 1992; Wäscher, 1987). However, a theoretically when productivity can be measured in units.
structured and comprehensive system of ABC was For further clarification between ABC and traditional
introduced for the first time in the ‘1980 (Kaplan and costing system we can differentiate between these two
Bruns, 1987). In this technique, we established the as presented in Table 2 (Karadað, Samli, and Öztürk,
different activities or the development of activities which 2009):
show the small group of homogenous tasks in all the

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A comparative study of the different costing techniques
and their application in the pharmaceutical companies

Table 2. ABC system and traditional costing. Comparative analysis

Traditional/Absorption costing ABC costing
Only manufacturing costs are allocated to the product. The manufacturing and non-manufacturing costs can be allocated
to products (some manufacturing costs might not be included in
the product cost, it varies from situation to situation).
Administrative, selling and general expenses are considered Administrative, selling and general expenses can be considered
as a period cost. as product costs if they have a direct relationship with the product
cost.
The factory over head is charged to production on the basis There are many factory overhead costs based on the multiple
of a single overhead rate for the entire factory. The base allocation basis.
may be direct material cost, direct labour hour, direct labour
cost and machine hour etc.
Unused capacity costs can be considered as products cost. Idle capacity costs cannot be considered as product costs.

Source: Authors’ processing.

According to Garrison, Noreen and Brewer (2004), the language because the target population consists of well-
following are the limitations of the ABC costing. educated people, so they can easily understand an
international language. There was a total number of 15
· To implement the ABC system there is need of more questions in the questionnaire; it took 5-7 minutes for the
resources, hence it is more costly than traditional respondents to complete the questionnaire. Our sample
costing. size was of 130 managers/accountants of the
· The ABC system provides the numbers e.g. product pharmaceutical companies which are working in the
margins and it odds with the numbers produced in Punjab. 130 questionnaires were distributed to the
the traditional costing. The managers are used to respondents in the month of December 2011. A simple
employ traditional costing to run business operations random sampling technique was used for distribution of
and traditional costing is frequently used the questionnaires. The data were collected through
for performance evaluations. personally administrated questionnaires. Out of 130
questionnaires 96 were received back. The response
· The data based on the ABC costing can easily be rate was 74%. The descriptive and graphical analysis
misinterpreted for making decisions, therefore the were used for the statistical analysis. The questionnaire
manager has to care full for making decisions based was already used by the other researchers, so there is
on the ABC costing, by considering which cost is no issue of reliability. A covering letter is also forwarded
relevant or irrelevant. to the respondents regarding the importance of the
· The ABC method is also not conforming to the study. The most important purposes of the current
generally accepted accounting principles (GAAP), survey are presented below:
therefore the organization has to prepare the 1. What costing system was used and adopted by the
statement on the basis of two methods: one for pharmaceutical companies in Punjab?
external and one for internal purposes.
2. Do the pharmaceutical companies have a position
for the cost accountant/ manager/accountant for
2. Research methodology costing?
The study was conducted on the pharmaceutical 3. On what basis is the overhead charged to production
companies of Punjab, Pakistan. The questionnaire was in the pharmaceutical firms?
used for the data collection from the pharmaceutical 4. Do the pharmaceutical companies have standards
companies. In this study the questionnaire of Hatzis et for costing?
al. (2011) was used for the data collection, after making 5. Do the companies use the accounting software
the necessary amendments to adapt to the Pakistani package that supports the process of costing?
culture. The questionnaire was designed in the English

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 Muhammad ALEEM, Alamdar Hussain KHAN, Wasim HAMAD

6. What is the major problem faced by the Participants

pharmaceutical companies during costing? The participants to the survey are managers or
7. Up to what extent are the managers satisfied with accountants or any persons who are dealing with the
their costing system? costing system in the pharmaceutical sector in the
8. Which one is best system of costing for decision Punjab, Pakistan. The demographic information of the
making? participants is presented in Table 3.

Table 3. Participants’ demographic profile

Particular Range Frequency Percent% Cumulative Percent
Male 84 87.5 87.5
Gender Female 12 12.5 100
Total 96 100
18-24 6 6.2 6.2
25-31 45 46.9 53.1
30-38 26 27.1 80.2
Age (years) 36-45 12 12.5 92.7
42-52 5 5.2 97.9
above 52 2 2.1 100
100 100.0
Undergraduate 7 7.3 7.3
Graduation 18 18.8 26.0
Education
Master 65 67.7 93.8
M. Phil/PhD 6 6.2 100.0
1-6 91 41.4 41.4
7-13 51 23.2 64.5
Job Experience (years)
14-20 37 16.8 81.4
Above 20 41 18.6 100.0
Source: Authors’ processing.

Demographics are not the part of analysis in the current age groups are included in our sample. It is also clear
study. It is just included in the paper to disclose the that most respondents hold a master degree and are
composition of the participants/respondents. Table 3 also experienced in the pharmaceutical sector. The
shows the gender discrimination The male respondents different age group, both type genders, low to high
are 88% and female are only 12%. Males are qualification personal and experienced respondents
dominating in Pakistani society. The reason of the low show that the data is the true representation of the
participation of women in manufacturing is that in population involved in the costing activities in the
Pakistani culture the males are supposed to earn pharmaceutical sector.
money, and women are supposed to look after the home
affairs and not earn money themselves. However, this
trend is changing with the passage of time and females 3. Costing systems
are also getting education and joining the public and Table 4 shows the outcomes of the analysis regarding
private sector. However, the 12% participation of the costing system in the pharmaceutical sector, which
females is very low as compared to USA or any Western is the main objective of this survey. Table 4 indicates
country (Bashir and Khattak, 2008). that the majority of the pharmaceutical sector is currently
The majority of the respondents are in the age of 25-30, using the marginal costing system for the cost
which shows that young people are involved in the estimation, which is very important for the internal
pharmaceutical sector; however, Table 3 shows that all costing. The ABC system is used in very few firms due
to its complexity. 35 out of the 96 respondents use the

1258 AUDIT FINANCIAR, year XIV

A comparative study of the different costing techniques
and their application in the pharmaceutical companies

absorption costing (37%), 47 respondents (49%) use system, meaning 15% approximately.
marginal costing, and 14 firms are using the ABC

Table 4. Costing methods used in the pharmaceutical industry

Costing systems Frequency Percent

Absorption Costing 35 36.5
Marginal costing 47 49.0
Activity based costing 14 14.6
Total 96 100.0
Source: Authors’ processing.

Indirect costs the direct labour cost, as per the survey results, because
this is a major cost element. The following graph shows
The manufacturing cost is charged on a different basis in
that most of the pharmaceutical firms use the direct
each sector. The basis of absorbed manufacturing
labour cost as a basis for manufacturing overhead; the
overhead may be the direct labour hours, direct labour
machine hours and direct material are used by some
cost, machine hours, material cost, prime cost and
firms only.
conversion cost, etc. However, in the pharmaceutical
sector the manufacturing cost is charged on the basis of

Figure 1. Indirect costs allocation bases used in the pharmaceutical industry

Source: Authors’ processing.

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 Muhammad ALEEM, Alamdar Hussain KHAN, Wasim HAMAD

Standard for Cost 26% of the pharmaceutical companies use no software

for the costing process.
The costing system is based on some standards or
principles that dictate the manner in which the record of
costing is maintained, for managerial decision making. Problems in the costing system
As per the survey results, 75% of the pharmaceutical In the pharmaceutical sector, the following problems
companies have a standard for costs, and the remaining were examined regarding the costing system:
25% has no standard for costs. · Incorrect allotment of indirect costs,

Accounting Manager · Complexities in the raw data assembly process,

Most of the pharmaceutical companies have the position · Delays in the gaining of accurate costing information.
of cost accounting manager, who manages the The most important problem which the pharmaceutical
organization’s costing system . 66% of the companies companies face in terms of the costing system is the
have the position of the accounting manager and 34% of incorrect allocation of indirect costs, according to the
the organizations have no proper set up of accounting managers’ answers to the questions in the survey. 54
manager and the costing system is managed by other respondents argue that the major problem is the
categories of employees. incorrect allocation of indirect costs, 20 respondents are
of the view that the delay in gaining the accurate costing
information is the major problem and 23 respondents are
Accounting software of the view that the main problem in costing consists in
In the current era of technology, most organizations use the complexities in the raw data assembly process. The
the accounting software for keeping the accounting following table shows the managers’ responses
records. 74% of the pharmaceutical companies use a regarding the problems faced by the pharmaceutical
cost accounting software for the costing system, while sector.

Table 5. Costing particularities specific to the pharmaceutical industry

Particulars Frequency %
Wrong allocation of indirect cost 53 55.2
Delays in acquisition of right costing system 20 20.8
Difficulties in raw data collection 23 24
Source: Authors’ processing.

Satisfaction level are using, 30% are neither satisfied nor dissatisfied
and 10% are not satisfied with the system. It is also
The other major objective of the survey is to observe
observed that the firms which are using the ABC
the satisfaction level of the respondents regarding
system are most satisfied as compared to those
the costing systems which they are using in the
firms who are using the marginal and absorption
pharmaceutical sector. Managers may be satisfied
costing, however the following graph shows the level
with the costing system, or dissatisfied, or neither
of the respondents’ satisfaction, neutral position and
satisfied nor dissatisfied. The results show that 60%
dissatisfaction.
of respondents are satisfied with the system that they

1260 AUDIT FINANCIAR, year XIV

A comparative study of the different costing techniques
and their application in the pharmaceutical companies

Figure 2. The level of respondents’ satisfaction with regard to the costing method they use

Source: Authors’ processing.

Decision Making the marginal costing is better, 10% opted for the
absorption costing and 28% stated that the ABC
The last and most important objective of the research system is best suited for decision making. The
was to show which costing system is better for decision following graph shows the managers’ responses
making. Most managers argue that the marginal regarding the best suited costing system for decision
costing is better for decision making, as compared to making.
absorption costing and ABC costing. 59% argue that

Figure 3. Costing methods adequate for the pharmaceutical industry

Source: Authors’ processing.

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 Muhammad ALEEM, Alamdar Hussain KHAN, Wasim HAMAD

· The managers of the companies that are using the

Conclusions ABC system are more satisfied with the costing
In the current era, there is great importance of the techniques, as compared to those using any other
pharmaceutical companies, because they deal with the costing techniques.
human life. The pharmaceutical companies try to provide · The companies have standards for costing and also
quality products along with minimizing the cost. The use a software for costing.
profit of the organization depends on the costing · Most managers are of view that the marginal costing
techniques which the organization uses. is better for decision making as compared to any
The major objective of this paper was the evaluation and other techniques.
identification of the costing system, and other relevant · The major problem which the organization is facing
issues which are of great importance for the costing in the costing system is the incorrect allocation of the
system used by the pharmaceutical companies in the indirect cost.
Punjab (Pakistan). The significant results of the survey In the future, the study can be conducted to examine the
were the following: drawbacks and plus points of using any costing
· Most companies in the Pakistani pharmaceutical techniques in the pharmaceutical companies, as well as
industry use the marginal costing, instead of the the impact on the profit by changing the costing
absorption or ABC costing. techniques.

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