Allocating overhead costs to departments based on their specific resource consumption typically leads to more accurate product costing. For example, a department heavily reliant on machinery would absorb a larger share of factory overhead related to equipment maintenance than a department primarily focused on manual labor. This refined cost allocation provides a more precise understanding of the true cost drivers within each department.
This improved precision offers several advantages. It allows for more informed pricing decisions, as businesses can better understand the profitability of individual products or services. Furthermore, it enables more effective cost control by highlighting areas of potential inefficiency within specific departments. Historically, simpler methods like applying a single, plant-wide overhead rate often obscured these nuances, leading to potentially distorted cost information and less effective management decisions.
