amortized cost method

The Allocation of Unabsorbed Overhead

Unabsorbed overhead costs can occur in many circumstances, including business cycles that experience reduced activity and hence results in lower absorption of costs than planned. These unabsorbed costs can include raw materials, spare parts, payroll costs, indirect labor, administrative expenses, etc. When the cause of the unabsorbed costs can be identified and definitively attributed to one or more business units or divisions, the way in which the costs are allocated is to determine the proper amount to be allocated to the respective business unit.

Methods for allocating unabsorbed overhead costs depend on the circumstances causing the unabsorbed costs, the amount involved and the impact of the allocation among the divisions or business units within the organization. One of the more common methods is to use a prorated basis which takes into consideration the unit’s level of contributions to the overhead costs. This may be determined by sales, production levels or other measure of activity. Other factors may be considered, such as the degree of control exercised by the unit over the costs or the cost sensitivity of the unit.

Another method for allocating unabsorbed overhead costs is to use a gradual approach, where the costs are spread over a multi period in a systematic manner. This approach helps to reduce the impact of large unabsorbed costs and allows for more equitable sharing of the burden among the respective divisions or business units. For example, if there were $100,000 in unabsorbed costs that was determined to be spread out over four periods, the cost allocation would be $25,000 for each period.

The last method of allocating unabsorbed overhead is the lump-sum approach, which requires that each affected division or business unit accept a portion of the unabsorbed costs based on the activity or contribution in proportion to the other divisions. This approach may be suitable when the cause of the unabsorbed costs is difficult to measure, such as sudden and unexpected changes in the marketplace. However, the lump-sum method of allocation is often unfair because the least affected unit may be forced to absorb more than its pro rata share of the unabsorbed costs.

Regardless of the method chosen, it is essential that the allocation of unabsorbed overhead costs be fair, equitable and properly supported. The allocation process should be well documented and reviewed by all parties involved, both before and after the process is completed. The allocation should also be in accordance with accepted accounting principles, including any specific guidelines prescribed by the applicable organization or external body.

In conclusion, the allocation of unabsorbed overhead costs is a critical task for any organization experiencing this situation. When properly done, the allocation of unabsorbed overhead cost can serve to fairly, equitably, and systematically spread the burden among the respective business units. Establishing and documenting the appropriate allocation of unabsorbed overhead costs is essential in order to ensure accuracy, reduce risk, and provide a clear understanding of the financial impact of the situation.

In accounting, the term “cost allocation” refers to the process of assigning costs from one activity to another. This process is usually done on a periodic basis, and helps businesses to gain better insight into their costs and the activities that are generating the most revenue. One of the most popular methods for cost allocation is the allotment of remainder costs, or “traceable costs.” This method assigns costs directly to activities in a business, based on the resources that were consumed or used to produce a product or service.

The method of allotment of remainder costs allows businesses to better analyze the costs of each activity and to make sure that resources are being used effectively. This is particularly useful when trying to determine if a certain activity is generating more costs than profits. With this method, businesses can track exactly what resources were used to complete an activity and how much of it was spent on each activity.

The procedure for cost allocation remains the same regardless of the type of business. It begins with determining the initial cost of resources that were consumed. This could be for labor, materials, or services that were involved in a particular activity. Once the initial costs are identified, the business will then estimate the cost of additional resources that were consumed in the activity. This includes such things as overtime wages, bonuses, or any other associated costs.

The next step is to determine the percentage of usage that each of the resources is having in the activity. This will typically be determined by dividing the cost of the resource consumed by the total cost of the resources that have been used up till that point. Finally, the percentages are multiplied by the total cost of all resources used in the activity to determine the total allocable costs.

Using this method of traceable cost allocation, businesses are able to better track the costs of each activity and make more informed decisions about where resources should be allocated. It is also effective for planning budgeting and forecasting. With this information, businesses can reduce their overhead costs and make sure their activities are as profitable as possible.