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Tessa believes that because departmental overhead costs are allocated based on measures closely related to production...

Tessa believes that because departmental overhead costs are allocated based on measures closely related to production volume, they accurately assign overhead, such as utility costs. Is this a true or false belief?

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Answer #1

It is a false belief that overhead costs allocated on basis of production volume are accurately assigned overheads. Volume-based overhead assignment tends to understate the cost of low volume products. A company can have numerous product where even though the volume of production of one product might be marginally lower than the other products, however, the cost might be the highest as it may require expensive materials for its manufacturing.

Therefore allocation of overheads on basis of volume may cause ineffective management of operations, unprofitable cross-subsidization of products and may cause incorrect decisions to be taken by the management. Volume based decisions are usually preferable when the company is producing only one product.

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