Allocation and Apportionment of Overheads (Depart-Mentalisation of Overheads)
Most of the manufacturing process functionally are different and performed by different departments in a factory. Where such a division of functions has been made, some of the departments would be engaged in actual production of goods while others in providing services ancillary thereto.
For the efficient working, a factory is divided into a number of sub-divisions. Such sub-divisions are referred to as departments. In other words, departmentalisation of overhead means dividing the factory into several segments called departments or cost centres to which expenses are charged. This sub-division is done in such a manner so that each department represents a division of activity of the organisation such as repairs department, power department, tools department, stores department, cost department, cash department, etc. The following factors are taken care of while dividing an organisation into number of departments:
The departments in a factory can be broadly categorised into the following types:
Advantages of Departmentalisation:
Allocation of Overheads
After having collected the overheads under proper standing order numbers the next step is to arrive at the amount for each department or cost centre. This may be through allocation or absorption. According to the Chartered Institute of Management Accountants, London, cost allocation is “that part of cost attribution which charges a specific cost to a cost centre or cost unit”. Thus, the wages paid to maintenance workers as obtained from wages analysis book can be allocated directly to maintenance service cost centre. Similarly indirect material cost can also be allocated to different cost centres according to use by pricing stores requisitions.
Apportionment of Overheads
Apportionment refers to the distribution of overheads among departments or cost centres on an equitable basis. In other words, apportionment involves charging a share of the overheads to a cost centre or cost unit. CIMA, London has defined it as “that part of cost attribution which shares costs among two or more cost centres or cost units in proportion to the estimated benefit received, using a proxy”. Apportionment is done in case of those overhead items which cannot be wholly allocated to a particular department. For example, the salary paid to the works manager of the factory, factory rent, general manager’s salary etc. cannot be charged wholly to a particular department or cost centre, but will have to be charged to all departments or cost centres on an equitable basis.
1. Primary distribution of overheads
Primary distribution of overhead involves allocation or apportionment of different items of overhead to all departments of a factory. This is also known as departmentalisation of overheads. While making primary distribution the distinction between production departments and service departments disregarded since it is of little use. The distribution of different items of overhead in different departments is attempted on some logical and reasonable basis.
Basis of apportioning overhead expenses: It is stated that the total overhead expenses of a department comprises direct overhead expenses incurred in the departments itself as well as the apportioned overhead expenses of other service departments. Expenses directly incurred in the departments which are jointly incurred for several departments have also to be apportioned e.g. expenses on rent, power, lighting, insurance etc. In other words, common expenses have to be apportioned or distributed over the departments on some equitable basis. The following basis are most commonly used for apportioning items of overhead expenses among production and service departments.
|Basis||Items of Overheads|
|1. Floor area||Rent, rates and taxes paid for the building, air conditioning, etc.|
|2. No. of employees or wages of each department||Group insurance, canteen expenses, E.S.I. contribution, general welfare expenses, compensation and other fringe benefits, supervisions etc.|
|3. Capital values||Insurance and depreciation of plants, machinery and equipments.|
|4. Direct labour hours||Works manager’s remuneration, general overtime expenses, cost of inter-department transfers etc.|
|5. No. of light points||Electric light|
|6. Horse power of machines or machine hours||Electric power|
|7. Audit fee||Sales or total cost|
|8. Value or weight of direct material||Stores overheads|
|9. Weight, volume, tonne, mile.||Delivery expenses|
2. Re-apportionment of service department overheads (Secondary Distribution)
Normally products do not pass through service departments, but service departments do benefit the manufacture of products. Therefore, it is logical that product cost should bear and equitable share of the cost of service departments. The process of redistribution of the cost of service departments among the production departments is known as secondary distribution.
Criteria for secondary distribution
Following is a list of basis, which are frequently used for apportionment of cost of service departments among production departments:
|Service department costs||Basis of apportionment|
|1. Maintenance department||Hours worked for each department.|
|2.Employment/personnel department||Rate of labour turnover or number of employees in each department.|
|3.Payroll or time department||Direct labour hours, machine hours number of employees.|
|4.Stores keeping department||No. of requisitions, quantity or value of materials.|
|5.Welfare department||No. of employees in each department.|
|6.Internal transport service||Truck hours, truck mileage or tonnage.|
|7.Building service department||Relative area of each department.|
|8. Power house||Floor area, cubic contents|
Methods of Re-apportionment or Re-distribution
At first expenses of all departments are compiled without making a distinction between production and service departments but, then, the expenses of the service departments are apportioned among the production departments on a suitable basis. It is also possible that expenses of one service department may also be apportioned in part to another service department to arrive at the total expenses incurred on the latter department, which will then be distributed among production department.
Following are the methods of re-distribution of service department costs to production departments:
(i) Direct distribution method: Under this method, the cost of service department are directly apportioned to production departments, without taking into consideration any service from one service departments to another service department.
(ii) Step method: In this method the cost of most serviceable department is first, apportioned to other service departments and production departments. The next service department is taken up and its cost is apportioned and this process is going on till the cost of last service department is apportioned. The cost of last service department is apportioned among production departments only.
(iii) Reciprocal service method: This method gives cognizance to the fact that where there are two or more service departments, they may render service to each other and therefore these interdepartmental services are to be given due weight in distributing the expenses of service departments. There are three methods available for dealing with inter service department transfer :
Absorption of Overheads
Absorption of overheads refers to charging of overheads to individual products or jobs. The overhead expenses pertaining to a cost centre are ultimately to be charged to the products, jobs etc. which pass through that cost centre. For the purpose of absorption of overhead to individual jobs, processes or products, overheads absorption rates are applied. The overhead rate of expenses for absorbing them to production may be estimated on the following three basis.
Actual and pre-determined overhead rate: The overhead absorption rate may be computed either based on actual cost or on the basis of estimated cost:
Actual Overhead Rate
This is also known as historical overhead rate. This rate is obtained by dividing the overhead expenses incurred during the accounting period by the actual quantum (quantity/value) of the base selected. This rate is determined as follows:
|Actual overhead rate = Actual overhead for the period / Actual quantuty or value of the base for the period|
This method suffers from the following limitations:
Pre-determined Overhead Rate
Pre-determined overhead rate is determined in advance of the actual production and is computed by dividing the budgeted overhead expenses for the accounting period by the budgeted base for the period i.e.
|Pre-determined overhead rate = Budgeted overhead for the period / Budgeted base for the period|
This computation of a pre-determined overhead rate is more practical and has the following advantages:
Blanket and Multiple Overhead Rates
Blanket overhead rate refers to the use of one single or general overhead rate for the whole factory. The blanket rate is used in those factories :
(a) Where only one major product in continuous process is being produced.
(b) Where several products are produced it can be applied only if:
(i) all products pass through all departments; and
(ii) all products are processed for the same length of time in each department.
This rate is calculated as follows:
|Blanket overhead rate = Overhead cost for the entire factory / Base for the period|
When different rates are computed for each producing department, service department, cost centre, each product or product line, each production factor, and for fixed overhead and variable overhead, then they are known as multiple rates. It is calculated as under:
|Overhead Rate = Overhead cost allocated and apportioned to each cost entre / Corresponding base|