Chapter 7

Manufacturing Overhead-
Departmentalization
 The need for departmentalization and its
procedures.
 The different classifications of department and
calculation of departmental overhead application
rates.
NEED FOR DEPARTMENTALIZATION

• In large businesses, factory operations are divided into

departments which is called the departmentalization.
• Departmentalization requires the use of different
overhead rates for applying manufacturing overhead.
Various amounts of manufacturing overhead are
charged to jobs or products as they pass through the
different departments.
CLASSIFICATION OF DEPARTMENTS
Producing departments
• Are those departments that are directly engaged in the
manufacturing activities.
Service Departments
• Are those departments that assist indirectly by rendering
services to producing departments.
PROCEDURES OF DEPARTMENTALIZATION

• Calculate departmental predetermined overhead application

rates.
• Apply the predetermined overhead rates to production on a
department basis.
• Record actual manufacturing overhead costs by departments in
the Departmental Overhead Analysis Sheet.
METHODS OF ALLOCATING SERVICE DEPARTMENT
COSTS TO PRODUCING DEPARTMENT

Direct Method
The costs of each service department are
allocated ONLY to producing
departments.
Costs of
Producing
Service Department
Department
METHODS OF ALLOCATING SERVICE DEPARTMENT
COSTS TO PRODUCING DEPARTMENT
Step Method
• Allocates service department costs to all service departments as well as producing
departments. This method allocates service costs to the operating departments and
other service departments in a sequential process.
• The sequence of allocation generally starts with the service department that has
incurred the greatest costs. After this department’s costs have been allocated, the
service department with the next highest costs has its costs allocated, and so forth
until the service department with the lowest costs has had its costs allocated.
• Costs are not allocated back to a department that has already had all of its costs
Producin
allocated. g
Costs of Departme
Service nt
Departme Service
nt Departme
nt
Illustration:
Assume the following data for August 2020:
Service Department Allocation Bases
Personnel Number of employees in each
producing department
Building maintenance Floor space occupied by each
producing department
Power plant Kilowatt hours of power usage in
producing department

The following data for each department during August 2020 are obtained:
Number of Floor Kilowatt
Department Costs Employees Space Hours
Service Department
Personnel P 3,600 5 1,500 -
Building Maintenance 2,000 4 2,500 -
Power Plant 1,000 2 4,000 -

Producing Department
Machining 11,800 10 10,000 7,000
Assembly 8,600 20 10,000 3,000
Direct Method
SERV PRODU
Depart
Department Costs Machining Assembly CING
ICE
Personnel P 3,600 P 1,200 P 2,400
Bldg. Maintenance 2,000 1,000 1,000

Power Plant 1,000 700 300

P 6,600 P 2,900 P 3,700
 Step Method
 Step Method
Allocated Costs
Building Power
Department Cost Personnel Maintenance Plant Machining Assembly
Personnel P3,600 P (3,600)
P 400 P 200 P1,000 P2,000
Building
Maintenance 2,000 (2,400) 400 1,000 1,000
Power Plant 1,000 (1,600) 1,120 480
P6,600 P3,120 P3,480
METHODS OF ALLOCATING SERVICE DEPARTMENT
COSTS TO PRODUCING DEPARTMENT

Reciprocal Method
• Provides a way to adjust for the reciprocal services
provided among the service departments.
• Service department costs and service department
reciprocal service relationships are described by an
algebraic equation.
Producin
g
Costs of Departme
Service nt
Departme Service
nt Departme
nt
 Illustration: Reciprocal Method

Assume the following data for Departments A, B and C which provides services
to each other and to producing departments X and Y.
Percentage of Services
Total Cost A B C X Y
A – P200,000 - 15% 5% 55% 25%
B – 140,000 10% - 9% 18% 63%
C – 100,000 - - - 20% 80%
Reciprocal Method Solution
• The following equations may be developed:
A (costs) = P200,000 + .10B
B (costs) = P140,000 + .15A
C (costs) = P100,000 + .05A + .09B
The equations may be solved algebraically as follows:
We can use substitution method:
1. A = P200,000 + .10B
A = P200,000 + .10 (P140,000 + .15A)
A = P200,000 + 14,000 + 0.015A
A - .015A = P214,000
.985A = P214,000
A = P214,000/ .985
A = P217,259
Reciprocal Method Solution
2. B = P140,000 + .15(P217,259)
B = P140,000 + 32,589
B = P172,589

3. C = P100,000 + .05A + .09B

C = P100,000 + .05(P217,259) + .09(P172,589)
C = P100,000 + P10,863 + P15,533
C = P126,396
The allocation of costs of Service Departments A,
B and C according to percentage of services:

A B C X Y
Cost prior to allocation P200,000 P140,000 P100,000 P - P -
Allocation of A (217,259) 32,589 10,863 119,492 54,325
Allocation of B 17,259 (172,589) 15,533 31,066 108,731
Allocation of C ________ ________ (126,396) 25,279 101.117
Total P -0- P -0- P -0- P175,837 P264,163
 Let’s Try This:
The Vico Company has two service departments and two producing departments.
The following are the overhead of each department:

Service Department:
Factory Administration P129,000
Building and Grounds 105,000
Producing Department:
Machinery 416,000
Assembly 380,000

Additional Information:
Estimated Total Labor
Department Square Footage
Hours
Factory Administration 2,900 1,200
Building and Grounds 1,100 1,500
Machinery 2,000 1,900
Assembly 1,600 3,200

The costs of factory administration are allocated based on estimated labor hours;
building and grounds costs are allocated based on square footage. The producing
department uses machine hours, with 30,000 for machinery and 22,800 for assembly.

Required:
Allocate the cost of the service departments to the producing departments by using
the following methods:
a. Direct method
b. Step method
c. Reciprocal method
Direct Method
Department Costs Machinery Assembly

Factory
P 129,000 P 71,667 P 57,333
Administration

Building and
105,000 P 39,118 P 65,882
Grounds

  P 234,000 P 110,785 P 123,215

Additional Information:

Total costs after allocation:

Machinery: P416,000 + P110,785 = P526,785
Assembly: P380,000 + P123,216 = P503,216

Factory overhead rates (based on machine hours):

Machinery: P526,785 / 30,000 = P17.56 per hour.
Assembly: P503,216 / 22,800 = P22.07 per hour
Step Method
Allocated Costs

Factory Building and

Department Cost Machinery Assembly
Administration Grounds

Factory 𝟏,𝟏𝟎𝟎 𝟐,𝟎𝟎𝟎 𝟏,𝟔𝟎𝟎

P129,000 P (129,000) P 30,191 P54,894 P43,915
Administration 𝟒,𝟕𝟎𝟎 𝟒,𝟕𝟎𝟎 𝟒,𝟕𝟎𝟎

Building and 𝟏,𝟗𝟎𝟎 𝟑,𝟐𝟎𝟎

105,000 P(135,191) 50,365 84,826
Grounds 𝟓,𝟐𝟎𝟎 𝟓,𝟐𝟎𝟎

P234,000 P105,259 P128,741

Additional Information:

Total costs after allocation:

Machinery: P416,000 + P54,890 + P50,362 = P521,252
Assembly: P380,000 + P43.911 + P84,837 = P508,748
 
Factory overhead rates (based on machine hours):
Machinery: P521,252 / 30,000 = P17.38 per hour
Assembly: P508,748 / 22,800 = P22.31 per hour
Reciprocal Method
The following equations may be developed:
Factory administration (costs) = P129,000 + .23B
Building & Grounds (costs) = P105,000 + .19F

Estimated Total Labor

Department Square Footage
Hours
Factory Administration 2,900 1,200 (1,200/6,300) = 19%
Building and Grounds 1,100 (1,100/4,700) = 23% 1,500
Machinery 2,000 (2,000/4,700) = 43% 1,900 (1,900/6,300) = 30%
Assembly 1,600 (1,600/4,700) = 34% 3,200 (3,200/6,300) = 51%
Substitution:

 F = P129,000 + .19 (P105,000 + .23F)

F = P129,000 + P19,950 + .0437F
.9563F = P148,950
F = P155,757
 
 B = P105,000 + .23(P155,757)
B = P105,000 + P35,824
B= P140,824
Cost Allocations:
Factory Administration allocations:
Building and grounds: P155,757 x .23 = P35,824
Machinery: P155,757 x .43 = P66,976
Assembly: P155,757 x .34 = P52,957

Building and Grounds allocations:

Factory administration: P140,824 x .19 = P26,757
Machinery: P140,824 x .30 = P42,247
Assembly: P140,824 x .51 = P71,820
Total cost after allocations:

Total cost after allocations:

Building &
F. Admin. Grounds Machinery Assembly
Direct cost P129,000 P105,000 P416,000 P380,000
F. Administration (155,757) 35,824 66,976 52,957
Bldg. and Grounds 26,757 (140,824) 42,247 71,820
Total P 0 P 0 P525,223 P504,777
F/O rates P17.51 P22.14
END OF PRESENTATION