We often find that improper costing of fixed costs and capital, such as the cost of capacity, creates misleading signals of performance and value in a business’s portfolio. First, traditional costing systems today ignore the cost of capital. Second, the treatment of excess capacity is often incorrectly treated as a unit cost, instead of the period expense that it truly is.
Indirect overhead costs are often capitalized and recorded as inventory, rather than expensed as period costs. The capitalization of overhead costs where there is no cost for capital actually makes these costs “free,” and creates a great short-term incentive to overproduce to inventory rather than make to demand. This characteristically leads to month-, quarter- and year-end production spurts, production-planning problems, excess inventory, trade loading, and stale, discounted product pushed onto the customer.
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