Question

Why are different methods of allocating overhead needed? What problems would occur if all business' used one method?

Answer 1

There are various methods of allocating overheads such as:

• Machine hour based
• Labour hour based
• Activity Based
• Area of the Factory - Rental Overheads

It is pertinent to note that the most important reason that various methods of allocation exist not all based on a form of production methodology may be one is based on Machinery, another one is working with labors and another on both. Also, there might be some business which has such complex business processes that it will incorrect to allocate overheads based on machine hours or labor hours or both. That is the reason why there are various methods of allocation of overheads exists.

The problems that might occur if all businesses used only one method that will be an incorrect charge of overeheads on various job order and products. It will result in distorted management accounting records and incorrect profitability. One business might charge incorrect amounts from different customers just because of distorted allocation of overheads.