Allocation Bases That Do Not Drive Overhead Costs: A Comprehensive Guide

The Importance of Proper Allocation Bases

In order to accurately determine the overhead costs for any given product or service, it is essential to use proper allocation bases. These allocation bases are the factors used to determine how costs are allocated to different products or services. Inaccurate allocation bases can lead to distorted cost figures, which can have negative impacts on pricing decisions and overall profitability.

Common Allocation Bases

Traditionally, allocation bases have included direct labor hours, machine hours, and direct material costs. However, these allocation bases may not always accurately reflect the true costs of producing a product or service. For example, if a product requires a significant amount of setup time, using direct labor hours as an allocation base may not accurately reflect the true cost of the product.

Allocation Bases That Do Not Drive Overhead Costs

There are several alternative allocation bases that may be more appropriate for allocating overhead costs. Some of these include:

1. Number of Orders

If a product requires a significant amount of setup time, it may be more appropriate to use the number of orders as an allocation base. This will more accurately reflect the true cost of the product, as setup time is directly related to the number of orders.

2. Number of Units Produced

For products that require significant labor or machine time, using the number of units produced as an allocation base may be appropriate. This will more accurately reflect the true cost of the product, as the labor and machine time required will be directly related to the number of units produced.

3. Square Footage

For companies that have significant overhead costs related to rent or maintenance of facilities, using square footage as an allocation base may be appropriate. This will more accurately reflect the true cost of each product, as the overhead costs can be directly related to the amount of space used to produce each product.

4. Number of Employees

For companies that have significant overhead costs related to employee salaries and benefits, using the number of employees as an allocation base may be appropriate. This will more accurately reflect the true cost of each product, as the overhead costs can be directly related to the number of employees required to produce each product.

Conclusion

Using proper allocation bases is essential for accurately determining the overhead costs associated with producing a product or service. While traditional allocation bases such as direct labor hours and machine hours may be appropriate in some cases, alternative allocation bases such as number of orders, number of units produced, square footage, and number of employees may more accurately reflect the true costs of producing each product. By using the appropriate allocation bases, companies can make informed pricing decisions and improve overall profitability.