Does a product lose money on the cost sheet? Before dropping it, allocate overhead by cost center and compare absorption costing with contribution margin: see what each center charges per hour, what idle capacity costs and what happens to profit if the product goes.
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Period total by product under both methods.
Direct cost plus each center’s overhead per unit, with the selling price.
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It is spreading over products the costs you cannot measure per unit: supervision, maintenance, general power, quality, rent. Each cost center has a base (machine hours, labor hours, units, floor area); the rate is center cost ÷ base quantity, and each product gets rate × what it uses.
Under absorption, each product carries a share of all plant costs, fixed ones included; it is the cost required for financial statements and taxes (ASC 330, IRC §263A). Under variable costing, the product carries only what changes with volume, and fixed costs go entirely to the period. Variable costing’s contribution margin is what you really lose when you drop a product.
The four centers add up to $70,440 of overhead. Machining has 1,800 machine hours and used 1,670: a $19.50/h rate and $2,535 of idle cost; Assembly, $8.40/h and $3,108 of idle cost. Profit for the period is $29,880 under both methods. The special pulley costs $48.79 under absorption and sells for $45.00 (a $1,137 loss), but its contribution margin is $7,047.
Only if its contribution margin is negative. In the example, dropping the special pulley would cut profit from $29,880 to $22,833, because the fixed costs of machining, the building and the other centers would remain. Before dropping it, review price, time in expensive centers and the allocation base.
It is the cost of capacity not used: machine and labor hours paid for but idle. Applying overhead on normal capacity (as ASC 330 requires) sends unallocated fixed overhead to the period. That way product cost does not rise when sales fall, and idle cost shows up separately, where you can act on it.
The one that best explains its spending: machine hours for machine areas (power, depreciation, upkeep), labor hours for manual assembly and finishing, units for inspection and shipping, floor area for rent, property tax, cleaning and security. A poor base distorts cost: an expensive center allocated by units penalizes simple, cheap products.
It allocates directly from centers to products, with no reciprocal allocation between service centers (maintenance serving machining, for example). It assumes everything produced is sold in the period and each center’s variable share is proportional to its base. For activity-based costing (ABC), split the centers into activities and use the bases as cost drivers.
Important notice: Indus Metrics tools produce estimates and pre-sizing results from the data you enter and from published engineering methods. They do not replace design, calculations or reports signed by a licensed professional engineer (PE), nor verification against the applicable codes, standards and regulations, such as OSHA rules and the ASME codes. Material and fuel properties vary: check manufacturer data or your own process analyses before deciding. By using this site you agree to the Terms of Use.
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