DEPARTMENTALISATION OF OVERHEADS

 INTRODUCTION

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 labor and direct expenses. CIMA defines indirect cost as “expenditure on labor
materials or services which cannot be economically identified with a specific saleable
cost unit”. Overhead expenses include accounting fees, advertising, insurance, interest,
legal fees ,labor burden, rent, repairs, supplies, taxes, telephone bills, travel expenditures,
and utilities. In big organizations of factories, there exist a number of departments. Some
departments are engaged in the process of production, while others are involved in
rendering services to production department. In this project we explore detaily about the
departmentalization of overheads.

 OBJECTIVE :

 The objectives of making this project is to understand about the various department in
the organization and the overheads incurred
 It also helps to analysis the primary and secondary distribution of overheads.

 CHAPTERIZATION

 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.

In Cost Accounting the analysis and collection of overheads, their allocation and
apportionment to different cost centres and absorption to products or services plays an
important role in determination of cost as well as control purposes. A system of better
distribution of overheads can only ensure greater accuracy in determination of cost of
products or services. It is, therefore, necessary to follow standard practices for allocation,
apportionment and absorption of overheads for preparation of cost statements.

 TYPES OF DEPARMENT

 Introduction to the types of departmentalization in a company

There are basically five types of departmentalization in organizations. The five types of
departmentalization are: functional, product, customer, geographical and process.

 Functional departmentalization

Most companies practice functional departmentalization. An example is the Production

department, HR department, Accounts department, Marketing department and IT
department.
 Product departmentalization

When a company has a wide range of products, product departmentalization is a logical

choice. For example, Kimberly Clark manufactures children’s products, toiletry and
industrial hygiene products. .Each product cluster has its own manufacturing plant,
research and development, and marketing team.

 Customer departmentalization

When a company has different customer bases, customer departmentalization allows

bettecustomer servicing. A travel agency can have one team taking care of corporate
customers, and the other team taking care of walk-in retail customers.

 Geographical departmentalization

Geographical departmentalization is good for a multi-national company. The company

can hire local employees to serve different customers from different geographical
locations The different offices in different countries usually report to a regional
headquarter. For example, the regional headquarter for Asia is in Singapore, and the
regional headquarter for Europe is in London.

 Process departmentalization

Process departmentalization is practiced in many factories with assembly line. The

employees are grouped into a team to take care of a specific process.

 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 manager’s salary, such as expense would have to be
apportioned depending on a fair criteria. This could be something like the percentage of
the manager’s 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. 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

 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’.

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 totalnumber of labour or machine hours worked in each department. Majority of
general overheaditems 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
directwages 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:

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
basisfor 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 manager’s 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 beapportioned to different departments on the basis of machine hours
or capital value of the 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,
(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.

 PRIMARY DISTRIBUTION AND SECONDARY

Primary distribution of overheads refers to allocation and apportionment of overhead
expenses among production and service departments of an organisationThis 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.

 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

 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 aservice 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
 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. There are three
methods of reapportionment of overheads under reciprocal service method.
These are:
(i) Simultaneous Equation Method
(ii) Repeated Redistribution Method
(iii) Trial and Error Method Illustration

PROBLEUMS

Clerical Stores Tool Production shops Services room

X y z
Direct Labour cost ($) - 12500 5000 45000 30000 25000
Indirect materials ($) 15000 40000 35000 20000
Machine hours 50000 30000 20000
Clerical services ($) Stores ($ ) Tool room ($)
Service departments 13750 9750 5000
costs as per primary X ($) Y ($) Z ($)
distribution Production 40250 35650 33800

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