TAMIL NADU NATIONAL LAW SCHOOL

TIRUCHIRAPPALLI

ACADEMIC SESSION:
2016-2017

COST ACCOUNTING
PROJECT:
DEPARTMENTALISATION OF OVERHEADS

SUBMITTED BY:

Gunjan Chandavat
ROLL NO. BC0140023

1
Acknowledgement

I take the opportunity to express my profound gratitude and deep regards to my guide for
Dr.T.S.Agilla her exemplary guidance, monitoring and constant encouragement throughout the
course of the project. The help and guidance given by him time to time shall carry me a long
way in the journey of life which I will embark .

I also express a deep sense of gratitude to our Vice Chancellor for giving me this opportunity. I
am obliged to my parents for showing faith which helped me in completing the project on time.

Lastly, I thank , my friends for their encouragement without which the assignment would have
not been possible.

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 DECLARATION

I, GUNJAN CHANDAVAT hereby declare that the project work entitled

DEPARTMENTALISATION OF OVERHEADS, submitted to Tamil Nadu National Law
School, Tiruchchirappalli, is the record of a bona fide work done by me under the supervision
and guidance of Dr. T.S AGILLA, Faculty of Finance System and Markets, the Tamil Nadu
National Law School, Tiruchchirappalli.

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 CERTIFICATE

This is to certify that the Research Project entitled: DEPARTMENTALISATION OF

OVERHEADS, submitted to the Tamil Nadu National Law School; Tiruchchirappalli, in
fulfillment of the requirements for internal component for B.COM; LL.B (HONS.), FOURTH
Semester is an original and bona fide research work carried out by GUNJAN CHANDAVAT,
under my supervision and guidance. No part of this study has been submitted to any University
for the award of any Degree or Diploma whatsoever.

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 OBJECTIVES

The objectives of making this project DEPARTMENTALISATION OF OVERHEADS is to

understand about the various department in the organization and the overheads incurred. It also
helps to analysis the the primary and secondary distribution of overheads. During the conclusion
of this paper there are illustration worked out for better understanding .

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TABLE OF CONTENTS:

1. CHAPTER-I 7

2. CHAPTER-II 11

3. CHAPTER-III 13

4. CHAPTER-IV 21

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CHAPTER I INTRODUCTION :
INTRODUCTION TO OVERHEADS:

Definition: Cost relating to a cost centre or cost units consists of direct cost and indirect cost.
Direct cost can easily be identified with cost units. Direct is the aggregate of direct material,
direct labour and direct expenses. The indirect cost constitutes the overheads which is the total
of indirect material labour and indirect expences. Indirect cost cannot be traced specifically to
any units of production. CIMA defines indirect cost as expenditure on labour materials or
services which cannot be economically identified with a specific saleable cost unit.

Overhead expenses are all costs on the income statement except for direct labour, direct
materials, and direct expenses. Overhead expenses include accounting
fees, advertising, insurance, interest, legal fees ,labor burden, rent, repairs, supplies, taxes,
telephone bills, travel expenditures, and utilities.

On the Basis of Function of Departments

1. Production Department Overheads

All the production department's overheads will include in this. Its other name is factory
overheads or manufacturing overheads. It includes all indirect expenses like factory building
rent, factory electricity and factory indirect material like grease, oil and spare clothes and cotton
and indirect labor includes factory store keeper salary, factory supervisor and peon and
watchmen's salary.

2. Sales and Distribution Department Overheads

For promotion of sales, there is need of paying sales department overheads. It includes the
indirect expenses of salaries and commission of salesmen, showroom rent, salesmen's travelling
expenses, advertising and bed debts.

3. Other Department Overheads

Except production centers and sales departments, there are lots of other department which
include in administration and office. So, it includes salaries of office employees, office lighting

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and electricity, repair and depreciation of office asset and vehicles, carriage outward, and
warehouse expenses.
On the Basis of Production Activities

1. Fixed Overheads
All overheads which do not change if there is change in the production, all such overheads will
be fixed overheads.

2. Variable Overheads
All the overheads which change due to change in the production, will be the variable overheads.

3. Semi-Variable Overheads are those which have both fixed and variable overheads qualities.
Such expenses will be fixed at certain level of production after this, these expenses will change
according to change in the production.1

DEPARTMENTALISATION OF OVERHEADS:

In big organizations of factories, there exist a number of departments. Some deparments are
engaged in the process of production, while others are involved in rendering services to
production department.The former type of department is known as production department and
the latter is called a service department Whenever a factory incurs overheads, they will have to
be charged on these two type of departments. The process of allocation and apportionment of
overheads to various departments is termed as departmentalization or primary distribution of
overheads. Proper allocation and apportionment of overheads serves the following purposes:

1. It helps in the ascertainment of cost with greater accuracy.

2. It helps in control of cost by assigning and identifying costs with the particular
department.
3. It helps in accurate forecasting and estimating.
4. It facilitates correct ascertainment of work-in-progress.

1 http://accountlearning.blogspot.in/2010/06/meaning-and-classification-of-overheads.html

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After collecting and categorizing overheads within suitable account headings the next step
included overhead distribution is the departmentalisation of these overheads to different cost
centres on an appropriate basis. This includes two stages

(a) Allocation of overheads: The process of charging the full amount of overhead costs to a
specific cost centre is known as Allocation. This is feasible while the nature of expenses is such
that it can be simply identified with a particular cost centre. For instance, the salary paid to a
foreman of a specific production department can be directly recognized with that department and
so it will be directly charged to that department.

(b) Apportionment of overheads: It is the technique of dividing up an item of overhead cost

and charging it to the cost centres on an equitable basis. This is completed in case of those
overhead items that cannot be fully allocated to a particular department. For instance, the salary
paid to the works manager of the factory cannot be charged fully to a particular production
department but must be charged to all departments of the factory on an equitable basis.

Though, in common parlance no such type of distinction is observed. The basis of apportionment
and the explanation of apportionment are referred to in the card maintained for each Standing
Order/ Cost Account Number. For instance, rent of the factory will be apportioned over several
departments of the factory as per to the area occupied through each department. The amount of
rent that each department has to bear will be referred to in the standing order number card
allotted to rent. Similar is true for other items.

Advantages of Departmentalization of Overhead Expenses:

Departmentalisation of overhead expenses has the following advantages:

1. Allocation and apportionment of overhead expenses to the respective departments facilitate

control of overhead cost by means of budgets predetermined.

2. Apportionment of service department cost to production and other service departments

facilitates control of the uses made of the services rendered to respective departments.

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3. Absorption of overhead costs in the products produced by departmental overhead rates
facilitates ascertainment of cost as the overhead costs of the respective departments are taken
into consideration in determining the overhead rates.

4. The basis used in the predetermination of the departmental overhead rates may be used for
control of actual basis in comparison to the quantity predetermined.

5. Analysis of under or over absorption of overhead discloses the reasons for variances which
indicate the remedial measures to be taken.

6. For working out correctly the cost of work-in-progress. If the overhead is not
departmentalised, the cost of work-in-progress will be loaded with a proportion of overhead of
all the departments including those in which the product is yet to be processed.2

2 http://www.theglobaltutors.com/Accounting-Homework-Help/Cost-Accounting/Overheads-
Departmentalisation

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CHAPTER- II :TYPES OF DEPARMENT

Types of Departments:

In a manufacturing concern, there are three types of departments:

(a) Manufacturing or producing departments

(b) Service departments

(c) Partly producing departments.

() Producing Departments:

A department where actual process of manufacturing is carried on is called manufacturing or

producing department. It covers direct manufacture and is engaged in converting raw materials
into finished goods by performing some manual and/or machine operations on any part of the
product.

The number of such departments and their number will depend upon the nature of industry, type
of work performed and the size of the factory. For example, in Steel Rolling Mill, Hot Mill, Cold
Mill, Pickling Shop, Annealing Shop, Hardening, Polishing and Grinding are the producing
departments.

(b) Service Departments:

Service department is an auxiliary and is not directly engaged in production though its existence
is very essential for smooth and efficient running of production departments. Such departments
are not directly engaged in the conversion of raw materials into finished goods. Such
departments (as electricity or repairs and maintenance) render a particular type of service for the
benefit of other departments.

The number of departments in a factory and the names to be assigned to them depends upon size
of the factory, nature of industry and the nature of service rendered. The service departments,
common to most concerns are stores, cost office, personnel department, planning and progress

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department, tool room, hospital and dispensary, machine maintenance and electrical maintenance
section etc.

(c) Partly Producing Departments:

A department may normally be a service department but sometimes does some productive work,
so it becomes partly producing department. For example, a carpentry shop which is mainly
responsible for the repairs and upkeep of sundry fixtures and fittings may occasionally be
required to manufacture packing boxes for direct charge to outturn, will be a partly producing
department.

Following factors must be taken into consideration while organising a concern into a
number of departments:

(i) Every manufacturing process is divided into its natural divisions in order to maintain natural
flow of raw materials from the time of the purchase till its conversion into finished goods and
sale.

(ii) For ensuring smooth flow of production, the sequence of operations is taken into
consideration while determining the location of the various departments.

(iii) For physical control on production and maintaining efficiency of the concern, division of
responsibility must be taken into consideration while organising departments. Division of
responsibility as far as possible should be clear, without ambiguity and dual control.3

3 http://www.yourarticlelibrary.com/cost-accounting/overheads-cost-accounting/allocation-and-
apportionment-of-overhead-to-cost-centres/55631/

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CHAPTER-III ALLOCATION ,APPORTIONMENT OF OVERHEADS

What is Allocation?

Cost allocation occurs when overheads and expenses are charged directly to the cost center. For
example, the cost of direct labour (such as labour cost per unit produced) is directly allocated to
the specific cost center which in this case will be a cost center related to manufacturing of goods.
Another example would be, if an air conditioning unit is used separately by one department, the
entire cost of using the air conditioner will be allocated to that specific department. There are a
number of conditions that needs to be met in order for an overhead to be allocated. These
conditions are that the expense must have been caused by the cost center and the specific amount
of the expense or overhead should be known.

Allocation of overheads/expenses is more specific, and exact cost amounts can be charged
directly to each cost center. However costs such as the salary of management personnel who is in
charge of overseeing all departments cannot be allocated to one department and, therefore,
another method must be used for distributing such costs.

What is Apportionment?

Cost apportionment occurs when a specific cost cannot be directly identified with one specific
cost center. Any cost that does not belong to one department and is shared by a number of
departments will be divided among these departments using apportionment. Taking the previous
example of the managers salary, such as expense would have to be apportioned depending on a
fair criteria. This could be something like the percentage of the managers time taken up in each
specific department. Other overheads that require apportionment include property rent, water and
utility bills, general administration salaries, etc. Expenses such as rent, water and utilities can be
fairly shared among departments by using a basis such as square feet per department space.

What is the difference between Allocation and Apportionment?

Allocation and apportionment are methods that are used to divide up costs among various cost
centers depending on which department or cost center each cost or portions of each cost belong.

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The major difference between allocation and apportionment methods are that allocation is used
when the overhead can be directly related to one department and cost center, and apportionment
is used when the overhead arises from a number of departments.

In allocation, the entire amount of the cost will be allocated to one department, and in
apportionment proportions of the costs will be divided among their respective cost centers.
Allocation is much easier and simpler to do as the expense will directly be related to one cost
center. Apportionment can, however, be quite tricky as the percentage of the cost that needs to be
assigned to each department may be difficult to decide.4

Allocation vs Apportionment

Allocation and apportionment are methods that are used to assign various costs to their
respective cost centers. Allocation can only be used when the entire expense is directly related to
one department and apportionment is used when proportions of the expense arise from a number
of different departments. The article offers a clear explanation of these terms with examples and
points out how these methods of assigning costs are different to each other.

Bases of Apportionment:

Suitable bases have to be found out for apportioning the items of overhead cost to production and
service departments and then for reapportionment of service departments costs to other service
and production departments. The basis adopted should be such by which the expenses being
apportioned must be measurable by the basis adopted and there must be proper correlation
between the expenses and the basis.

Therefore, the common expenses have to be apportioned or distributed over the departments on
some equitable basis. The process of distribution is usually known as Primary Distribution.

4 http://www.differencebetween.com/difference-between-allocation-and-vs-apportionment/

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Following are the main bases of overhead apportionment utilised in manufacturing
concerns:

(i) Direct Allocation:

Overheads are directly allocated to various departments on the basis of expenses for each
department respectively. Examples are: overtime premium of workers engaged in a particular
department, power (when separate meters are available), jobbing repairs etc.

(ii) Direct Labour/Machine Hours:

Under this basis, the overhead expenses are distributed to various departments in the ratio of total
number of labour or machine hours worked in each department. Majority of general overhead
items are apportioned on this basis.

(iii) Value of Materials Passing through Cost Centres:

This basis is adopted for expenses associated with material such as material handling expenses.

(iv) Direct Wages:

According to this basis, expenses are distributed amongst the departments in the ratio of direct
wages bills of the various departments. This method is used only for those items of expenses
which are booked with the amounts of wages, e.g., workers insurance, their contribution to
provident fund, workers compensation etc.

(v) Number of Workers:

The total number of workers working in each department is taken as a basis for apportioning
overhead expenses amongst departments. Where the expenditure depends more on the number of
employees than on wages bill or number of labour hours, this method is used. This method is
used for the apportionment of certain expenses as welfare and recreation expenses, medical
expenses, time keeping, supervision etc.

(vi) Floor Area of Departments:

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This basis is adopted for the apportionment of certain expenses like lighting and heating, rent,
rates, taxes, maintenance on building, air conditioning, fire precaution services etc.

(vii) Capital Values:

In this method, the capital values of certain assets like machinery and building are used as basis
for the apportionment of certain expenses.

Examples are:

Rates, taxes, depreciation, maintenance, insurance charges of the building etc.

(viii) Light Points:

This is used for apportioning lighting expenses.

(ix) Kilowatt Hours:

This basis is used for the apportionment of power expenses.

(x) Technical Estimates:

This basis of apportionment is used for the apportionment of those expenses for which it is
difficult, to find out any other basis of apportionment. An assessment of the equitable proportion
is carried out by technical experts. This is used for distributing lighting, electric power, works
managers salary, internal transport, steam, water charges etc. when these are used for processes.

Principles of Apportionment of Overhead Costs:

The determination of a suitable basis is of primary importance and the following principles
are useful guides to a cost accountant:

(i) Service or Use or Benefit Derived:

If the service rendered by a particular item of expense to different departments can be measured,
overhead can be conveniently apportioned on this basis. Thus, the cost of maintenance may be
apportioned to different departments on the basis of machine hours or capital value of the

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machines, rent charges to be distributed according to the floor space occupied by each
department.

(ii) Ability to Pay Method:

Under this method, overhead should be distributed in proportion to the sales ability, income or
profitability of the departments, territories, basis of products etc. Thus, jobs or products making
higher profits take a higher share of the overhead expenses. This method is inequitable and is not
generally advisable to relieve inefficient units at the cost of efficient units.

(iii) Efficiency Method:

Under this method, the apportionment of expenses is made on the basis of production targets. If
the target is exceeded, the unit cost reduces indicating a more than average efficiency. If the
target is not achieved, the unit cost goes up, disclosing thereby the inefficiency of the
department.

(iv) Survey Method:

In certain cases it may not be possible to measure exactly the extent of benefit wick the various
departments receive as this may vary from period to period, a survey is made of the various
factors involved and the share of overhead costs to be borne by each cost centre is determined.

Thus, the salaries of foreman serving two departments can be apportioned after a proper survey
which may reveal that 30% of such salary should be apportioned to one department and 70% to
the other department. The cost of lighting, when not metered, may similarly be apportioned on a
survey of the number and wattage of light points and the hours of use in each cost centre.

Illustration 1:

What basis would you follow for distribution of the following overhead expenses to
departments?

(a) Store Service Expenses,

(b) Employees State Insurance,

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(c) Factory Rent,

(d) Municipal Rent, Rates and Taxes,

(e) Insurance on Building and Machinery,

(f) Welfare Department Expenses,

(g) Creche Expenses,

(h) Steam,

(i) Electric Light,

(j) Fire Insurance.

Illustration 2:

The Modern Company is divided into four departments: P1, P2, P3 are producing departments
and S1 is a service department.

The actual costs for a period are as follows:

5 Supra 3

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PRIMARY DISTRIBUTION:

Primary distribution of overheads refers to allocation and apportionment of overhead expenses

among production and service departments of an organisation.

6 Ibid

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This process involves allocation of overheads which can be directly identified with a particular
department and apportionment of common item of overheads on appropriate basis among all the
departments.

The entire process of allocation and apportionment is systematically presented in a perform

which is known as perform of overheads distribution summary or primary distribution summary.
This performs is shown below for better understanding:

While preparing overheads distribution summary, it is important to note that the direct costs of
the service departments should be considered as overheads. Hence the direct material, direct
labour and direct expenses of the service departments are allocated directly and recorded in the
overheads distribution summary since these are overheads from production point of view.

But the direct material, direct labour and direct expenses of the production departments need to
be excluded from this summary since these are not overheads.7

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CHAPTER-IV: SECONDARY DISTRIBUTION OF OVERHEADS

In the primary distribution of overbids, the overhead expenses are distributed among all the
departments or cost centers, whether it is production department or service department.

In fact the production departments are engaged in producing goods where as service departments
assist them in the process of production. Hence ultimately the service department costs need to
be spread over the production department and only then the overheads can be charged to
production.

This process of apportioning service department expenses among the production departments is
called secondary distribution of overheads. In other words, secondary distribution is the
reapportionment of service department expenses among the production departments after
completion of primary distribution. While making secondary distribution, some common bases
of apportionment are taken.8

Methods of Secondary Distribution

In this method the costs of service departments are apportioned directly to the existing
production departments. Even though there are other service departments in the same
organisation, costs of one service department is not apportioned to other service departments. By
adopting this practice the services rendered by one service department to other service
departments are ignored.

Step Method

The defect of the direct redistribution method by ignoring the service rendered by one service
department to other service departments is removed in this method.

In this method the services rendered by one service department to other service departments is
considered while making apportionment. But one important aspect of this method is that a

8 http://www.preservearticles.com/2011092313989/what-is-secondary-distribution-of-overheads.html

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service department which renders service to another service department does not receive any
services from the later. For example, there are three service departments 'X', 'Y' and 'Z'.

The service department 'X' shall render services to 'Y' and 'Z', but shall not receive any services
from them. Similarly Service Department 'Y' shall render service to 'Z' but shall not receive any
service from 'Z'. Service Department 'Z' shall not render any service to either 'X' or 'Y' Under
such situation step distribution method of apportionment can be applicable.

Under this method the expenses of the most serviceable department is first apportioned to other
service departments and production departments. Then the next service department is taken up
for apportionment. This process shall continue till the last service department is apportioned only
to the production departments.9

Reciprocal Service Method

In the step method we noticed one defect that is the service department rendering services to
other service departments does not receive any services from them. But very often we come
across service a department which not only render services to other service departments but also
receives services from them.

In other words, the services are rendered on reciprocal basis. For example, canteen as a service
department renders services, to the employees of maintenance department. Hence cost of canteen
must be apportioned to maintenance department. Now the maintenance department also renders
services to the canteen and hence a part of its cost must be apportioned to canteen.

This method of reapportionment is known as 'Reciprocal Service Method'. Here one thing must
be remembered that the calculations become very complicated if we consider more than two
service departments. Hence for all practical purpose we have taken two service departments
while reapportioning under reciprocal service methods.10

There are three methods of reapportionment of overheads under reciprocal service method. These
are:
9 Ibid

10Ibid

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(i) Simultaneous Equation Method

(ii) Repeated Redistribution Method

(iii) Trial and Error Method

Illustration 3: From the following particulars, show the secondary distribution on non-
reciprocal basis:
Clerical Stores Tool Production shops
Services room X Y Z

Direct Labour cost ($) - 12500 25000 45000 30000 25000

Indirect materials ($) 15000 40000 35000 20000
Machine hours 50000 30000 20000

Clerical services ($) Stores ($) Tool room ($)

Service departments costs as per 13750 9750 5000

primary distribution
Production department costs as X ($) Y ($) Z ($)
Per primary distribution 40250 35650 33800

Notes:

(1) All other service departments & production department received clerical services.

(2) Tool room & production departments are served by the stores department.

(3) Only production departments are served by tool room department.

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 11

Illustration4:

Show the secondary distribution on direct redistribution method, on the basis of the
under mentioned particulars relating to the production departments, A1, A2 & A3 & the
service departments canteen, power house, store, time-keeping & accounts & repair shop.

Production Departments Cost after primary distribution ($)

A1 40000
A2 36000
A3 50000
126000

Service departments costs:

Canteen 3000
Power house (lighting) 2400
Power house (power) 8000
Stores 7200
Time-keeping & accounts 6000
Repair shop 9000
35600

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 Other information: A1 A2 A3

No of employees 60 50 40
No of light points 12 16 20
Horse power of machines 600 400 600
No of requisitions 8000 6000 10000
Value of assets ($) 200000 300000 400000

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