Allocation Bases That Do Not Drive Overhead Costs

Introduction

Overhead costs are an essential aspect of any business. They include costs such as rent, salaries, and utilities that are not directly linked to a product or service. Allocating overhead costs to products or services is necessary to determine their profitability. The allocation process involves identifying an allocation base and allocating the overhead costs based on the usage of the allocation base. However, some allocation bases do not drive overhead costs. This article will discuss these allocation bases and how they affect the allocation process.

What are Allocation Bases?

Allocation bases are used to allocate overhead costs to products or services. They are the factors that drive the consumption of overhead costs. Common allocation bases include direct labor hours, machine hours, and units produced. By using these allocation bases, manufacturers can identify the cost of producing each product or service.

Allocation Bases that Do Not Drive Overhead Costs

Not all allocation bases drive overhead costs. Some allocation bases are not related to the consumption of overhead costs. Here are some examples of allocation bases that do not drive overhead costs:

1. Sales Revenue

Allocating overhead costs based on sales revenue is not an accurate method as it does not relate to the consumption of overhead costs. High sales revenue does not necessarily mean high overhead costs. Allocating overhead costs based on sales revenue can result in incorrect cost calculations, leading to inaccurate pricing decisions.

2. Number of Employees

Allocating overhead costs based on the number of employees is not accurate as it does not relate to the consumption of overhead costs. The number of employees does not necessarily mean high overhead costs. Allocating overhead costs based on the number of employees can result in incorrect cost calculations, leading to inaccurate pricing decisions.

3. Square Footage

Allocating overhead costs based on square footage is not an accurate method as it does not relate to the consumption of overhead costs. Large square footage does not necessarily mean high overhead costs. Allocating overhead costs based on square footage can result in incorrect cost calculations, leading to inaccurate pricing decisions.

Problems with Allocating Overhead Costs

Allocating overhead costs can be a challenging task. It is difficult to identify an accurate allocation base that drives overhead costs. Allocating overhead costs based on inaccurate allocation bases can lead to incorrect cost calculations, resulting in inaccurate pricing decisions. Additionally, allocating overhead costs can lead to over or underpricing of products or services.

Conclusion

In conclusion, allocating overhead costs is an essential aspect of any business. The allocation process involves identifying an allocation base that drives overhead costs and allocating the costs based on the usage of the allocation base. However, some allocation bases do not drive overhead costs, such as sales revenue, number of employees, and square footage. Allocating overhead costs based on these allocation bases can result in incorrect cost calculations, leading to inaccurate pricing decisions. Manufacturers should identify an accurate allocation base to ensure accurate cost calculations and pricing decisions.