In: Categories » Legal and finance » Accounting » Problems That Arise from Allocation Process
|
The process of allocating overhead charges toindividual businesses can lead to several problems within a company. It Fosters Politics The process of allocating overhead charges toindividual businesses fosters political infighting. When an executive shinesas a result of her contribution to the profitability of thebusiness, this is a positive result. However, when costs areallocated, a manager who knows how to manipulate the allocation methodologycan make his department’s performance look better bygetting charges assigned to other operating units. When oneprofit center looks good at the expense of another, without thecompany benefiting at all, that’s politics. It Inhibits NewProduct Introductions Accounting methodology assigns a portion of theexisting overhead to each new product when analyzing its profitability.This inflates the cost of the new product and causes theestimate of its contribution to profit to be severely understated.The analysis of a new product should include only costs that areincremental for that new product. Existing overhead that is notaffected should not be included. It Understates theProfitability of Business Beyond Budgeted Volume Overhead allocations are assigned to all products,regardless of volume. When sales surpass budgeted expectations, theaccounting department will continue to charge these allocationsto the individual products even though the company hasalready generated enough business to cover the actual corporateoverhead. These fictitious charges will continue to be addeduntil the end of the year. This leads to a significant understatementof the actual profits of each business that has had sales above thebudgeted number and may cause the company to underreward unitmanagers who surpass their sales budgets. It InhibitsMarketplace Aggressiveness Incremental business is really more profitable thanthe accounting information reveals. Larger customer orders permitlonger production runs and more efficient raw materialpurchasing. Traditional accounting information does not recognize this. The ability to give price breaks on larger orders(volume dis118 counting) because of these advantages cannot berecognized because overhead charges are assigned to all products. It OverstatesSavings from Eliminating ‘‘Marginal’’ Products A company should never eliminate products from its mixexcept under the following circumstances: 1. The product achieves a negative contributionmargin, and there is no opportunity to correct this situation. 2. The product is a quality disaster that will impairmarketplace perceptions of the entire business. 3. The company is near capacity and needs the spaceand machine time for more profitable offerings. Eliminating a product with a positive cash flowresults in the loss of that cash flow. Why is there confusion aboutthis? Because our accounting systems tell us that eliminating aproduct will save the variable labor costs and the correspondingoverhead assigned to the product. Labor costs, as anyone who has evermanaged a factory will tell you, are more fixed than variable.They will not be reduced appreciably, if at all, whenvolume declines. And overhead will not be reduced because the buildingdoes not get smaller, nor do the staff departments (includingaccounting).
|
legal disclaimer
1) Our website is not responsible for the information contained by this article as well for any and all copyright infringements by authors and writers. E-articles is a free information resource. If you suspect this article for any copyright infringements, please read the Terms of service and contact us to investigate the problem.
2) The E-articles directory team is not responsible for inaccuracies, falsehoods, or any other types of misinformation this tutorial may contain and will not be liable for any loss or damage suffered by a user through the user's reliance on the information gained here. Please read the Terms of service
Useful tools and features
If you like this article (tutorial), please link to it from your web page using the information above. Linking to this page, this is the only way to help us improve our service, the same time providing your visitors with a way to improve their online experience.
related articles
The Financial Accounting Standards Board (FASB) is a research organization, made up primarily of accountants. The FASB, along with the entire accounting profession, has, over time, developed a series of rules called generally accepted accounting principles (GAAP). In addition, the FASB publishes what are called FASB Bulletins. These are a series of more than one hundred publications that describe what corporate reporting methodologies should be. Most of these methodologies have been adopt...
2. Activity Based Management in Accounting
Activity-based management (ABM) is an approach to management in which process managers are given the responsibility and authority to continuously improve the planning and control of operations by focusing on key operational activities. ABM strategically incorporates activity analysis, activity-based costing (ABC), activitybased budgeting, life-cycle and target costing, process value analysis, and value-chain analysis. Enhanced effectiveness and efficiencies are expected for both revenue generation and...
3. What is accounting and general accounting principles and functions
Accounting is a body of principles and conventions as well as an established general process for capturing financial information related to an entity’s resources and their use in meeting the entity’s goals. Accounting is a service function that provides information of value to all operating units and to other service functions, such as the headquarters offices of a large corporation. Origin of Accounting Modern accounting is traced to the work of an Italian monk, Luca Pacioli, w...
4. SECTION 529 PLANS
Qualified tuition programs, or Section 529 plans, have been in existence in many states and in various forms since 1986. The programs were named after Section 529 of the Internal Revenue Code, which was enacted in 1996. Essentially, these are programs that are operated at the state level and gave the participant a number of benefits that include tax-deferred earnings. In this way, they were akin to a traditional IRA or a 401(k) retirement plan. The accounts are opened by one person for the benefit of another...
There are significant differences between accounting revenues and profits and the company's cash flow. These differences may derive from several sources, such as the following: Timing differences between sales and receipt of payments— The main differences are the result of timing differences between when sales are made and when payment for them is received. Cash will flow to the company only when payment is received for a transaction it made, unless the company has made an agreement whereby it sold...
6. Accounts Receivables and Inventories
Analyzing accounts receivable and inventory levels is arguably the most widely used method for spotting red flags. Accounts Receivables Unlike when they sell to us, a company doesn't usually require payment in advance when it sells to another firm. Instead, it bills the customer and specifies a payment due date. Accounts receivables are the monies owed by customers for goods already shipped and billed. Normally, you’d expect the receivables total to more or less track sales. That ...
7. Accounting principles Earning reports and Conference calls
Most companies issue a press release reporting their last quarter’s earnings within a few weeks of the quarter’s end. The SEC allows firms 45 days after the quarter’s end, and 90 days after the end of their fiscal year, to file their SEC reports, so the press release data could be all that you have to go on for some time. Companies usually conduct an analysts’ conference call within hours of the earnings release. Anyone can listen in on the conference call live, or listen to a recordi...
8. COMPOSING A STRATEGY DOCUMENT
Determining a Format The format for the document itself can be altered to fit the writing style and sophistication of the management team charged with implementing the strategy. The one must to writing the document will be focusing on its usability. The fact that the document will be circulated throughout the organization and relied on in the future is reason enough to develop an informative record of objectives and tasks. The finance strategist must recognize that this document will not only inform but also serve as a platf...
9. TRADITIONAL PERCEPTION OF THE FINANCE FUNCTION
For the small and emerging business owner, the greatest barrier to developing a sound finance function may be the traditional perception of finance and accounting. The erroneous perception of the finance function as the meticulously slow and detailed process that yields soberingly bad news of past performance must be addressed. The reality is that the finance function must be up to the task of steward of the most valuable data the enterprise will encounter. The responsibility of this stewardship requires that the finance fun...
10. FINANCE FUNCTION DEFINED
The finance function consists of the people, technology, processes, and policies that dictate tasks and decisions related to financial resources of a company. Depending on the organization and the industry in which it operates, this function may be simple or complex. Some finance functions are overstaffed that is, they rely on individuals to perform both advanced and simple tasks while others are highly automated relying on people for decision making and policy setting exclusively. Regardless of the ratio of people to technology, the ...