What is "cost distortion" in accounting?

Cost distortion occurs when the allocation of manufacturing overhead (MOH) to products is uneven, resulting in some products absorbing too much overhead cost while others receive too little. This imbalance can lead to misleading financial information, impacting pricing decisions, profitability analysis, and overall management effectiveness. In a standard costing system or traditional costing methods, if overhead is applied using a single plant-wide rate, it may not reflect the actual resource consumption of individual products, creating inaccuracies in cost reporting.

In contrast, the other options reflect different accounting concepts. Fair allocation of manufacturing overhead denotes an efficient costing system where all products fairly share the overhead burden, which does not represent cost distortion. Underestimating costs touches upon revenue recognition and expense matching issues, rather than the allocation variance characterized by cost distortion. Lastly, the relationship between variable and fixed costs does not directly relate to the uneven allocation of overhead costs to products, as this concern primarily deals with how costs behave rather than how they are assigned.