Allocations of overhead should not affect a project’s incremental cash flows unless the:
A project actually increased overhead expenses.
B overhead can not be recovered at the end of the project.
C overhead covers costs for the human resources department.
D accounting department wants to allocate costs to all projects.
The correct answer and explanation is:
The correct answer is A) project actually increased overhead expenses.
Explanation:
In project evaluation, overhead costs refer to the indirect costs that are necessary to run a business, such as rent, utilities, and administrative salaries. These costs are typically spread across multiple projects or departments within an organization. When assessing the incremental cash flows of a specific project, only the costs that directly result from the project should be considered.
Answer A highlights the scenario in which overhead expenses increase due to the specific project. If the project causes an increase in overhead costs—such as requiring additional administrative support or new resources—it would represent a genuine change in the business’s cash flows. These incremental costs should be included when calculating the project’s net cash flows.
Answer B refers to situations where overhead cannot be recovered at the end of the project. While this is an important consideration for long-term decision-making, it doesn’t directly affect the calculation of incremental cash flows. Incremental cash flows focus on changes in expenses or revenue directly caused by the project.
Answer C discusses overhead covering costs for the human resources department. If the HR department’s costs are shared by all projects, this may be an ongoing fixed cost. It wouldn’t directly impact a specific project’s incremental cash flows unless the project requires additional human resource management, which increases HR-related costs.
Answer D refers to general cost allocation decisions by the accounting department. While accounting departments might allocate costs for various purposes, these allocations should only affect the incremental cash flows of a project if they directly result in increased expenses. Simply allocating overhead costs across all projects does not necessarily reflect a change in the financial impact of the specific project being evaluated.
Thus, only when a project actually increases overhead costs should those costs be included in the project’s incremental cash flows.