Data Structure
Networking
RDBMS
Operating System
Java
MS Excel
iOS
HTML
CSS
Android
Python
C Programming
C++
C#
MongoDB
MySQL
Javascript
PHP
Physics
Chemistry
Biology
Mathematics
English
Economics
Psychology
Social Studies
Fashion Studies
Legal Studies
- Selected Reading
- UPSC IAS Exams Notes
- Developer's Best Practices
- Questions and Answers
- Effective Resume Writing
- HR Interview Questions
- Computer Glossary
- Who is Who
Sunk Costs and Allocated Overhead Costs
Sunk costs and allocated overheads are important topics in the evaluation of an investment. Sunk costs need to be ignored while making a new decision, whereas the allocated overheads are not quite good for cash flow estimations. Let’s have a bit more detailed study of these two factors that affect an evaluation of investments.
Sunk Costs
Sunk costs are funds that have been invested in the past that will make no difference to a current decision of funding a new project. The latter part is of importance to financial analysts and accountants because it shows the actual way a business must go ahead in case a former decision has yielded negative results.
Sunk costs are expenses that have been made in the past and they won’t affect the current decision of making another investment by a company.
It is critical because the new investment must consider a profitable option before investing again.
An Example of Sunk Cost
Let’s consider a case where an investor has made an investment of INR 100,000 but has not got positive results from the investment. The investment has sunk, but the investor wants to make another decision of investing INR 100,000 in a new project.
In this example, the yes or no is less important than the actual and correct thought process. The thought process should forget the sunk investments and the new investment should be made depending on the NPV of the new project. So, there will be a net outflow of funds that has no relation with the former one. That should be the approach of investing new funds in the case of sunk costs.
Allocated Overhead Costs
Overhead costs cannot be assigned directly to any activity. They pose a problem for accountants due to such qualities. This problem is solved by accountants by allocating the funds among different departments.
Example
For example, let us assume that there are three departments that need allocation of funds on a 2:2:1 basis according to their performances. Let’s say there is INR 100 that must be allocated among three departments A, B, and C. So, the division of the funds would be INR 40, INR 40, and INR 20.
Now let’s assume a fourth department needs allocation and the ratio now is 3:3:1:3. As the new allocation is made, the actual amount spent would be INR 120, and the departments will get INR 36, INR 36, INR 12, and INR 36 respectively.
It is therefore important to consider allocated costs rather than incremental costs while considering the allocation of overheads.
424 Views
