Question

What are the drawbacks for a company who does not allocate overhead costs to its products? Why might a company do this and what other controls would they have to implement to insure optimal performance?

Answer 1

Some of the drawbacks for a company that does not allocate overhead costs to its products are :

(I) the company cannot charge a higher price for the product and recover through the sale of the product.

(ii) It may result in employee demotivation since the company will try to recover the costs through other means such as salary cuts or reduction in other expenditure.

The company may do this to have a bigger market share through attractive pricing of the product and to compare the prices with the competitors. Also, not allocating overheads is a way to reduce the overhead costs and make the company more profitable. The controls that the company may have to implement to ensure optimal performance is through proper training of employees to avoid errors and re works, use of better technology, incentivize employees who undertake cost cutting measures, ensure managers are aware that the it is important to stick to budgets.