The relationship between overhead allocation techniques and financial performance of manufacturing companies in Kenya

Abstract

Overhead cost allocation has become, in the past few decades, one of the most serious problems related to cost management for companies. Accurately allocating overhead costs is one of the key criteria for effective product costing, meaning that correct managerial decisions can thus be made, an example being pricing decisions governing products consequently defining the financial performance of any manufacturing firm. In Kenya the manufacturing sector is dominated by subsidiaries of multinationals and a few indigenous manufacturers. Due to the high costs of production in the country, many of these subsidiaries are relocating from Kenya and are now represented by direct subsidiaries or appointed distributors. For efficiency and effectiveness manufacturing firms in Kenya therefore need to plan for success. This study sought to investigate the relationship between overhead allocation techniques and financial performance of manufacturing companies in Kenya. To this end, the study sought to answer the following research questions; what overhead allocation techniques have been adopted by the manufacturing companies in Kenya? What is the relationship between of overhead allocation techniques and financial performance of manufacturing companies in Kenya? This study adopted a descriptive survey design. The study population was forty manufacturing firms, out of a population of sixty five manufacturing companies in Kenya as registered by the ministry of industrialization (2014). Both primary data and secondary data were collected in this study. To ensure instrument validity, content validity was tested. Instrument reliability was achieved through test-retest reliability where the tools were administered twice to the same group of five respondents working in firms listed in NSE in a span of two weeks. Overhead allocation techniques data was summarized for each firm in table form to facilitate data analysis. In line with our first and second objective, the study used linear regression model. The linear regression model sought to establish the relationship between overhead allocation techniques and the financial performance. The study found out that majority of the manufacturing companies’ percentage of overhead costs to the total project costs were from 5% to less than 10% and all these companies have adopted various overhead allocation techniques. The study indicated that overhead allocation techniques significantly predicted the financial performance of manufacturing companies in Kenya. Activity based costing contributes the most to the financial performance of manufacturing companies in Kenya followed by Traditional allocation Method, size, Step-Down Allocation Method, Leverage and Reciprocal Allocation Method respectively. The study recommended that the manufacturing companies implement the ABC system as it assigns overhead costs more accurately than other cost accounting system from a cost management perspective.