The Significance of Indirect or Overhead Costs
Indirect and overhead costs such as rates and rent should be ignored when deciding on whether an additional sale should be made. Once an expense had been incurred or a commitment exists to incur it, that cost should be disregarded because they can be changed in the present or future.
Many people have difficulty taking a philosophical view of overhead costs as they were once a real expense.
On that basis the company’s overall profitability for year would be as follows:
Sales – budgeted £500,000
Sales – additional contract £25,000
Expenditure – budgeted £350,000
Expenditure – additional contract £19,000
Overall profit £156,000
This compared to the original budgeted profit of £150,000 suggests that the company would have been right to accept the additional contract to make 1,000 extra chairs.