Any business owner in the manufacturing sector knows firsthand that inventory management is much more than tracking boxes on shelves. It’s at the heart of your cost structure, your pricing, and your profits. Yet, two of the most common (and costly) inventory costing mistakes are often hiding in plain sight. Let’s break down why these two specific problems happen and how they can be impacting your business.
Overhead Allocation Errors: Getting the Full Picture
Not every cost in manufacturing can be easily identified and incorporated into your selling price. Overhead costs, like rent, machine depreciation, utilities, and indirect labor for example, need to be spread across the production of goods through a process called overhead allocation. If this isn’t done accurately, the numbers on your financial statements might be steering you in the wrong direction. Common issues include either allocating too little overhead, which inflates your gross margin and undervalues inventory, or allocating too much, which can make your products look less profitable than they really are. Sometimes, businesses switch between allocation bases—such as from labor hours to machine hours—without updating their processes, which results in confusion and inconsistent costing. Another frequent problem is using outdated overhead rates, especially after major changes in production volume, which leads to a distorted view of your inventory’s true value.
Misclassifying Inventory: When Little Mistakes Add Up
Manufacturing inventory travels through three main stages: raw materials, work-in-process (WIP), and finished goods. Accurate classification matters—not just for reports, but for your bottom line. In fast-moving production environments, it’s easy to accidentally confuse WIP and finished goods, or to let raw materials be miscategorized, especially when several people are handling inventory between the classifications. If the process of recording the status of partially completed goods isn’t correct, your books won’t reflect the actual state of production. Items that are returned for rework also must be properly reclassified; otherwise, you can end up with double-counted costs or missed adjustments that compound over time.
The consequences of misclassifying inventory are real. Costs can hit your income statement at the wrong times, which throws off your gross margin and makes it harder to manage profitability. Your balance sheet may show inaccurate inventory values, which can affect your relationship with lenders, insurers, or potential buyers. Bad data also undermines good decision-making in purchasing, production scheduling, and financial planning.
Why This Matters—and What You Can Do
So why does this matter so much? Inaccurate overhead allocation skews your cost of goods sold (COGS) and gross margin, making it difficult to measure true profitability. Mistakes here can also cause you to overpay or underpay your taxes and might trigger IRS scrutiny. On top of that, if your costing is off, every business decision—whether it’s pricing, production planning, or budgeting—could be based on unreliable information.
At Hedman Partners LLP, our CAAS professionals can help by reviewing your current overhead allocation process and recommending the method that best matches your business model. We can automate calculations to keep things consistent and reduce manual mistakes, and we’ll revisit your rates with you as your business grows or changes, so your costing stays accurate and up to date. We can also assist by helping you to create and maintain clear definitions and workflows for each stage of inventory, ensuring everyone on your team is on the same page.
Overhead allocation and inventory classification might seem like “just accounting details,” but they directly impact your profitability, compliance, and ability to make smart business decisions. With CAAS expertise, you get systems, processes, and training that bring clarity to your numbers—so you can focus on what you do best: running your business.
Ready to get a handle on your inventory accounting? Let us help you find and fix these hidden costing traps and improve your financial reporting. Click here if you are interested in a case study available where we implemented real-word changes to help a recent client or contact Janet Thomerson, CAAS Partner at (661) 286-1543 or Teddy Avendt, CAAS Senior Manager at (661) 310-2186 for more information.