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Allocation of fixed overhead: Does it really change profits

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Many accounting writers have emphasized the effect that the allocation of fixed overhead can have on managerial incentives to overproduce. When fixed overhead is allocated to product, the greater the production level, the lower the fixed cost per unit. The lower fixed cost per unit might increase perceived profitability, but is the company really more profitable?

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Solution Summary

Your tutorial is 262 words and explains how fixed product costs are the same (cash outflows for these costs) but the cost per unit may impact other parts of the business and therefore overall profits may not be the same.

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The simple answer is that the company has the same cash outflows and inflows for manufacturing costs, regardless of how it allocates the costs. So, you would be tempted to say that in one period the profits might look higher or lower but when all the costs finally flow through to cost of goods sold, the higher or lower profits will be offset in the later period. This is true. If you inventory fixed costs, those ...

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Carol Sargent, PhD
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  • BSc, University of Virginia
  • MSc, University of Virginia
  • PhD, Georgia State University
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