Understand Thoroughly Underallocated and Overallocated Indirect Costs Adjusted Allocation-Rate Approach
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What is adjusted allocation rate approach?
The adjusted allocation rate approach is adopted by organizations to correct or rewrite the overhead estimated costs for the entire year, in order to ensure the actual overhead costs are recorded correctly, without any error. In simple words, it’s a process to resolve the estimated costs predicted and the actual costs incurred.
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How does it affect underallocated or overallocated indirect costs?
In an organization, indirect costs are not easy to estimate, unlike company overhead. The overhead indirect costs may vary form one season to another. Like for example utilities. One month, the utility bill might be more and the other it might be less. In order to avoid such complications, most companies estimate such costs at the beginning of the financial year. However, the costs do not reflect reality and are far from the actual expenses incurred.
Thus, oftentimes funds get overallocated or underallocated. Adjusted allocation rate approach goes back to the ledger and fixes all the estimate rates in both the general and subsidiary ledger, at the end of the financial year. Thus, the overhead, indirect costs rates match the actual expenses.
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