Overheads+Allocation

FACTORY OVERHEADS ALLOCATION & DISTRIBUTION

Cost AssignmentCost Assignment

• The general term cost assignment refers to both tracing direct costs and allocating indirect costs to cost objects.

Cost Assigned

Direct materials and direct labor

Cost Tracing

Cost Object

(Job)FACTORY overhead

Cost Allocation

Manufacturing overhead

Factory Overhead Costs All manufacturing costs not classified as direct materials or direct labor.

FACTORY RENTS, RATES, LIGHTING/ HEATING

Miscellaneous materials & labour used in production

•LUBRICANT, COTTON WASTE

•WAGES OF INDIRECT WORKERS

Costs not traceable to products•DEP, REPRS & MAINT, NSURNCE OF FACTORY BLDG, Taxes•POWER & FUEL•SALARIES OF PRODUCTION MGT

Support (Service) Dept Costs•SALARIES, WAGES RELATED TO SERVICE COST CENTERS SUCH AS TOOL ROOM ETC•CANTEEN & STAFF WELFARE EXP•EXP FOR ADMINST OF FACTORY

Characteristics of Manufacturing Overhead Costs

Involves more complex accounting procedures and estimation problems.

Must often be estimated in advance of their occurrence.

Cannot be traced directly to individual items produced during the period.

Managers need current product cost information:– - for pricing similar jobs.

– - for estimating costs for next period.Therefore, each job is assigned a share of estimated overhead.

• Allocation

• A means of dividing a pool of costs and assigning those costs to various subunits

• Total cost is neither reduced or increased by allocation

• But …the amounts assigned to the subunits CAN be affected by the allocation procedure chosen

1What is Allocation

• Cost of manufacturing overhead needs to be allocated to various jobs in production. It is NOT a direct cost.

Why Allocation

• To obtain a mutually agreeable price.• To compute product-line profitability.• To predict the economic effects of planning and

control.• To value inventory.• To motivate managers.

Objectives

STEPS IN ALLOCATION • NO PROBLEM IN SINGLE PRODUCT ORGN

• COMPLEX IN MULTI PRODUCT ORGN• TWO STEPS INVOLVED

I. ALLOCATION & APPORTIONMENT• ESTIMATING OVERHEAD EXP FOR PERIOD

• COLLECTION & CODIFICATION

II. ABSORBTION OF OVERHEADS TO VARIOUS PRODUCTS

Service departments provide essential support for production departments (power house, canteen, repairs & maintenance)

Producing departments are directly responsible for the creation of goods or services sold to customers

Textile Industry: carding, spinning, weaving, dyeing, finishing

Goods and Services

Carry out the central purposes

of an organization.

Provide supportthat facilitates the

activities of production departments.

•First Step in Cost Allocation…..determine what the cost objects are!!!!!

Steps in Allocating Support Costs

• Usually the cost objects are departments

• Two types: producing and support

Corporate Examples

• OVERHEAD EXPENDITURE ESTIMATION (DONE FOR ALL FACTORY)– FIXED (MGT SALARY, DEP, RENT & TAXES)– SEMI VARIABLE ( INURANCE PREMIUM)– VARIABLE ( REPAIRS, INDIRECT LABOUR)

Steps in Allocating Support Costs

Departmentalize the firm Classify each department AS SERVICE

OR PRODUCING DEPARTMENT Trace all overhead costs in the firm to a

service or producing department. Allocate service department costs to

producing departments Calculate predetermined overhead rates

for producing departments Allocate overhead costs to units of

individual products through the predetermined overhead rates

Th

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•First Step in Cost Allocation…..determine what the cost objects are!!!!!

Two-Stage Cost Allocation• Stage I – all manufacturing overhead costs are

assigned to the firm’s production department.– First manufacturing overhead costs are assigned to

departmental overhead centers (Cost Distribution/Allocation).-PRIMARY DISTRIBUTION

– Second, all service department costs are reassigned to production departments (service department cost allocation).- SECONDARY DISTRIBUTION

• Stage II – the accumulated manufacturing-overhead costs in each department are assigned to specific production jobs (overhead application/absorption). This is done based on the predetermined overhead rate.

Two-Stage Cost Allocation

Total Indirect CostsRs1,550

Rs50 Rs100 Rs200

Rs300 Rs400 Rs500

Service Departments

Production Departments

Stage IPRIMARY DISTRIBUTION


Service department costs are allocated to production departments.

Service Departments


Rs50 Rs100 Rs200

Rs425 Rs550 Rs575

SECONDARY DISTRIBUTIONStage I



Production department costs are allocated to jobs and products.

Job 1 Job 2 Job 3

Rs 425 Rs550 Rs575

Stage II

STAGE -I FACTORY OVERHEAD ALLOCATION• ALLOCATION TO COST CENTERS IF IDENTIFIABLE

– PROCESS OF IDENTIFICATION OF OVERHEADS WITH COST CENTRES

– EXPENDITURES DIRECTLY IDENTIFIABLE WITH SPECIFIC COST CENTRE ALLOCATED TO SAME

– EFFORT MADE TO ALLOCATE AS MANY ITEMS AS POSSIBLE

– EXAMPLE• POWER IF SEPARATE METRE PROVIDED IN EACH COST CENTRE

• WAGES TO INDIRECT WORKERS

• DEP & INSURANCE OF PLANT & MACHINERY

• FUEL OIL FOR BOILER

– IDENTIFY OVHDS WHICH CAN BE DIRECTLY ASSIGNED TO VARIOUS PRODUCTION/SERVICE CENTRE BASED ON SOME RECORD

• INDIRECT LABOUR : IDENTIFIED WITH VARIOUS CENTERS ON BASIS OF PAY ROLL

• INDIRECT MATERIAL : IDENTIFIED ON BASIS OF MATERIAL REQUISITION SLIP

STAGE -I FACTORY OVERHEAD ALLOCATION• APPORTIONMENT (PRIMARY DISTRIBUTION)

– ALLOTMT TO TWO OR MORE COST CENTERS OF COMMON ITEMS OF COST ON ESTABLISHED BASIS OF BENEFITS RECEIVED

» RENT & RATES/DEP, REPAIRS & MAINT OF BLDG

» LIGHTING/ WORKS MGR’S SALARY

– USED FOR APPORTIONMENT OF COMMON OVERHEADS

– ALLOCATION OF COMMON OVHDS TO VARIOUS COST CENTERS ON SOME FAIR OR EQUITABLE BASIS (COST DRIVERS)

– EXAMPLE

•SPACE - FOR FACTORY RENT, PROPERTY TAXES

•LABOUR - FOR WAGE, EMPLOYEE WELFARE EXP

•ACTIVITY - FOR ELECTRICITY, POWER, DEP

When selecting a cost driver consider:

• The ease of obtaining data.

• The degree to which the cost driver measures actual consumption by products.


– RESULTS IN COLLECTION OF TOTAL FACTORY OVERHEADS UNDER VARIOUS PRODUCTION COST CENTRES

• WE GET TOTAL FACTORY OVERHEAD FOR EACH COST CENTRE

Item of Cost Basis of apportionment

Total (Rs)

P1 P2 P3 S1 S2

Rent & rate Floor area 5000 1000 1250 1500 1000 250General Lighting Light Points 600 100 150 200 100 50Indirect Wages Direct Wages 1939 600 400 600 300 39

Power Horse Power 1500 600 300 500 100 0Depreciation Value of machine 10000 2400 3200 4000 200 200

Sundries Direct Wages 9695 3000 2000 3000 1500 19528734 7700 7300 9800 3200 734Total

Primary distribution summary


– RESULTS IN ALLOCATION & APPORTIONMENT OF TOTAL FACTORY OVERHEADS UNDER VARIOUS SERVICE COST CENTRES


Total (Rs)

P1 P2 P3 S1 S2





STAGE -I FACTORY OVERHEAD ALLOCATION• REAPPORTIONMENT (SECONDARY DISTRIBUTION)


• THIS NEEDS TO BE REAPPORTIONED SO THAT THE TOTAL FACTORY OVERHEADS ARE COLLECTED UNDER PRODUCTION COST CENTRES ONLY (EASILY DONE)


Total (Rs)

P1 P2 P3 S1 S2







• THIS NEEDS TO BE REAPPORTIONED SO THAT THE TOTAL FACTORY OVERHEADS ARE COLLECTED UNDER PRODUCTION COST CENTRES ONLY (EASILY DONE)

• Direct allocation method: Allocates service department costs directly to production departments only.

• Step method: Allocates service department costs to one service department at a time in sequential order.

• Reciprocal method: Uses simultaneous equations. X

STAGE -I FACTORY OVERHEAD ALLOCATION• REAPPORTIONMENT (SECONDARY DISTRIBUTION) DIRECT


– THIS NEEDS TO BE REAPPORTIONED SO THAT THE TOTAL FACTORY OVERHEADS ARE COLLECTED UNDER PRODUCTION COST CENTRES ONLY (EASILY DONE)


Total (Rs)

P1 P2 P3 S1 S2





Direct Method

Direct Method

Charges costs of support- service departments to internal customers without making allocations among

service departments.

Charges costs of support- service departments to internal customers without making allocations among

service departments.

Allocations go directly to production or direct-service departments.This method ignores services

provided to other support service departments.

Allocations go directly to production or direct-service departments.This method ignores services

provided to other support service departments.

STAGE -I FACTORY OVERHEAD ALLOCATION• REAPPORTIONMENT

(SECONDARY DISTRIBUTION) DIRECT

STAGE -I FACTORY OVERHEAD ALLOCATION• REAPPORTIONMT (SECONDARY DISTRIBUTION) STEP

– REPEATED DISTRIBUTION METHOD (EASIEST TO FOLLOW)• OVERHEADS OF SERVICE COST CENTRES ARE REAPPORTIONED TO

OTHER SERVICE & PRODUCTION COST CENTRES ON BASIS OF PREDETERMINED PERCENTAGES

• PROCESS CONTINUES, UNTIL FIGURE UNDER SERVICE COST CENTRE EITHER GETS EXHAUSTED OR BECOME TOO SMALL TO BE OF CONSEQUENCE

Allocations begin with the service department with the largest proportion of its total

allocation base in other service departments

Allocations begin with the service department with the largest proportion of its total

allocation base in other service departments

Recognizes that some support-service departments provide

services to other support services as well as production and direct service departments

Recognizes that some support-service departments provide

services to other support services as well as production and direct service departments

Step Method

Step Method

STAGE -I FACTORY OVERHEAD ALLOCATION• REAPPORTIONMENT

(SECONDARY DISTRIBUTION) STEP



• SERVICES PROVIDED BY SOME SERVICING DEPARTMENT MAY BE USED PARTLY BY OTHER SERVICING DEPARTMENTS (interdepartmental services, difficult to apportion)

• example: building maintenance department provides services for all departments using building, but it gets services from departments like stores, factory office & personnel


Total (Rs)

P1 P2 P3 S1 S2





STAGE -I FACTORY OVERHEAD ALLOCATION• REAPPORTIONMT (SECONDARY DISTRIBUTION)

– REPEATED DISTRIBUTION METHOD (EASIEST TO FOLLOW)• OVERHEADS OF SERVICE COST CENTRES ARE REAPPORTIONED TO

OTHER SERVICE & PRODUCTION COST CENTRES ON BASIS OF PREDETERMINED PERCENTAGES

• PROCESS CONTINUES, UNTIL FIGURE UNDER SERVICE COST CENTRE EITHER GETS EXHAUSTED OR BECOME TOO SMALL TO BE OF CONSEQUENCE

Particulars P1 P2 P3 S1 S2Total Overhead 7700 7300 9800 3200 734Overhead of S1 (20:30:40:10) 640 960 1280 -3200 320Overhead of S2 (40:20:30:10) 422 211 316 105 -1054Overhead of S1 (20:30:40:10) 21 32 42 -105 10Overhead of S2 (40:20:30:10) 4 2 3 1 -10Overhead of S1 (20:30:40:10) 1 -1TOTAL 8787 8505 11442 0 0

Secondary Distribution Summary

Examples of Cost Drivers forSupport Departments

Accounting Number of transactions

Cafeteria Number of employees

Engineering Number of change orders

Maintenance Machine hours

Payroll Number of employees

Personnel Number of new hires

Support Department Possible Driver

STAGE -I FACTORY OVERHEAD ALLOCATION• REAPPORTIONMT (SECONDARY DISTRIBUTION)

– REASSIGNING SERVICE DEPTT OVHDS TO PRODUCING DEPTTS OR CENTERS

– FACTORY OVHD ALOOCTD & APPORTIONED TO SERVICE COST CENTERS ARE TO BE REAPPORTIONED TO PRODUCT COST CENTRE

» CANTEEN/ STORES/ MAINTENANCE DEPTT

» TIME OFFICE/ DISPENSARY– DONE FOR FINDING

• COST OF PRODUCT• VALUE OF INVENTORY• TOTAL COST OF BUSINESS FIRMS• DETERMINING PRICE OF PRODUCT/JOB

– GENERAL BASIS• PROPORTIONATE BENEFIT DERIVED

BY VARIOUS COST CENTRES

– WE USE• REPEATED DISTRIBUTION METHOD

10-30

COST ALLOCATION EFFECTSCOST ALLOCATION EFFECTS

If support-service departments provide significant services to eachother, the amounts of costs allocated to direct-service, production,

and marketing departments probably differ under each method.

If support-service departments provide significant services to eachother, the amounts of costs allocated to direct-service, production,

and marketing departments probably differ under each method.

Significantdifferences can effect:

Significantdifferences can effect:

ContractsContracts

Decision-making

Decision-making

Performanceevaluations

Performanceevaluations

Determine if the Cost Allocations Achieve Desired Results

10-31

COST ALLOCATION COSTS AND BENEFITSCOST ALLOCATION COSTS AND BENEFITS

Complex cost-allocationsystems are difficult

and costly to DESIGN


and costly to DESIGN


and costly to MAINTAIN


and costly to MAINTAIN

Cost-allocation systems may require revision in a continual process of improvement, which is costly but

can be justified if decisions and organizational performance also continue to improve.

Cost-allocation systems may require revision in a continual process of improvement, which is costly but

can be justified if decisions and organizational performance also continue to improve.

Determine if the Cost Allocations Achieve Desired Results

FACTORY OVERHEAD: ACCOUNTING• COLLECTION & CODIFICATION (THREE STEP PROCESS)

I. SYSTEMATIC COLLECTION RELATED TO SPECIFIC COST CENTRE

II. CODE No. ALLOTTED TO EACH A/Cg HEAD & EACH COST CENTRE

• FACTORY EXP-----CALLED STANDING ORDER No

• ADM, SELLING & DISTRIB--------CALLED COST A/C No

– CODING MAY BE • NUMERIC (MOST SUITABLE)

– 10/121/05/08

– COST/HEAD OF EXP/SPECIFIC EXP/COST CENTRE

– FIXED/SALARY/OFFICER/PRODUCTION

• ALPHABEDIC

• COMBINATION OF ABOVE TWO

III. EVERY DOCUMENT TO BEAR CORRECT COST CENTRE CODE & CORRECT STANDING ORDER No. OR COST A/C No.

FACTORY OVERHEAD: ACCOUNTING• SOURCE DOCUMENTS FOR OVERHEAD COLLECTION

– STORES REQUISTION ( FOR INDIRCT MATL A/Cg)• HAS COST CENTRE CODE WHICH HAS ASKED FOR MATERIAL• A/C HEADING UNDER WHICH VALUE OF MATL TO BE BOOKED

– INVOICES FOR SERVICES (ON BASIS OF PAYMT MADE & EXP BOOKED IN FINCL A/C)• USED FOR COLLECTION OF INDIRECT EXP• CORRECT CODE No TO BE INSCRIBED BEFORE SENDING TO A/C DEPTT

– ESTIMATES FROM FINCL A/C• EXPS WHOSE CHARGING SPREAD OVER MORE THAN ONE A/Cg PERIOD

COLLECTED FROM FINCL A/C– DEP, TRAINING EXP AT COLLABORATOR’S FACTORY

– WAGE ANALYSIS BOOK• SHOWS OVERHD CONTROL A/C TO WHICH INDIRECT WAGES &

SALARIES BOOKED

– CASH BOOK - FOR INDIRECT EXP

– REGISTERS & REPORTS• PLANT & MACHINERY REGISTER FOR DEP ETC

Overheads+Allocation

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