Question

Discuss how overhead costs influence management decisions.

Answer 1

Following are the ways by which overhead costs influence management decisions:-

1.Help a company set prices- Prices of product does not depend solely on direct cost. Overhead must be considered as well to effectively estimate the real profit.

2.Comply with US GAAP- US GAAP wants all manufacturing costs- direct material, direct labor and overhead to be assigned to products for inventory costing purposes. Hence, overhead plays pivotal role for meeting regulatory requirements.

3. Tool of monitoring the costs- It is very important to control overheads because they are not directly related to a product but if they become larger share of expenses , they can lead to lesser profit for an organisation.

4. Help in preparing holistic budget- Estimating overhead cost is very difficult because of its inherent nature to stay in shadow. It means overhead costs cannot be attributable to a product directly. Hence, they are allocated to each product later on. However, if we can estimate the correct amount of overhead costs in advance, then we can prepare the budget which is efficient and reliable.

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