PROBLEMS IN TRADITIONAL OVERHEAD COSTING
The current method of overhead costing would result in the following problems:
COST DISTORTION HINDERS PROFITABILITY ANALYSIS
Construction projects have different cost codes for each resource such as project engineer
or manager. They treat overhead costs separately and do not assign overhead costs to
work divisions such as earthwork or to participants such as subcontractors. However, they
assign overhead costs to work divisions in proportion to direct labor hours or direct labor
costs when owners request the assignment of overhead costs (Sommer 2001). Such
volume-based allocation results in cost distortion (Cokins 1996, Johnson and Kaplan
1987, Horngren et al. 1999).
The problem of current practice regarding overhead assignment is that companies do
not know real costs for each work division and those for each participants such as
subcontractors because either they do not assign overhead costs or they use a uniform cost
driver (i.e., direct labor costs) for assignment of overhead costs. Therefore, it is difficult
to find where money is being made and lost because progress payments for each work
division or building from clients contain overhead costs. In other words managements
have difficulty in doing a profitability analysis.