Apportionment of overhead expenses

Definition and meanings of apportionment of Overheads

There are certain overhead expenses which cannot be charged totally to a specific department or shop, Such expenses are apportioned in a suitable ratio over related departments or shops. Apportionment means distributing of overhead items to cost centers on a fair and reasonable basis.

Thus the principle is that if an overhead cannot be wholly allocated to a particular cost center, it must be apportioned over related cost centers. This involves finding out some suitable basis of apportionment that will enable the overhead to be equitably shared amongst concerned cost centers.

Procedure for apportionment of overhead expenses through departmentalization

For the purpose of apportionment of overhead expenses, the departments of a factory are divided into two categories i.e., production deparänents and service departments

Production Departments

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Production departments are the departments directly engaged in the manufacturing of products e.g., cutting, stitching and finishing packing departments of a garments factory.

Service Departments

Service departments are the departments that do not perform operations on products to be manufactured but provide auxiliary services to. support operations in production departments e.g., repair and maintenance, purchasing, storeroom, training, payroll departments etc.

Principles of apportionment of overhead expenses

The guidelines or principles which facilitate in determining a suitable basis for apportionment of overheads are explained below:

1. Derived Benefit

According to this principle, the apportionment of common items of overheads should be based on the actual benefit received by the respective cost centers. This method is applicable when the actual benefits are measurable. e.g., rent can be apportioned on the basis of the floor area occupied by each department.

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2. Potential Benefit

According to this principle, the apportionment of the common item of overheads should be based on potential benefits (i.e., benefits likely to be received). When the measurement of actual benefit is difficult or impossible or uneconomical this method is adopted. e.g., the cost of canteen can be apportioned on the basis of the number of employees in each department which is a potential benefit.

3. Ability to Pay

According to this principle, overheads should be apportioned on the basis of the saleability or income generating ability of respective departments. In other words, the departments which contribute more towards profit should get a higher proportion of overheads.

4. Efficiency Method

According to this principle, the apportionment of overheads is made on the basis of the production targets. If the target is higher, the unit cost reduces indicating higher efficiency. If the target is not achieved the unit cost goes up indicating inefficiency of the department.

5. Specific Criteria Method:

According to this principle, apportionment of overhead expenses is made on the basis of specific criteria determined in a survey. Hence this method is also known as “Survey method”. When it is difficult to select a suitable basis in other methods, this method is adopted. e.g., while apportioning salary of the foreman, a careful survey is made to know how much time and attention is given by him to different departments. On the basis of the above survey, the apportionment is made.

Stages of apportionment of overhead expenses

The overhead apportionment process is in two stages, namely primary and secondary apportionments. These two stages are explained below:

1. Primary Apportionment

Many items of overhead like fire insurance, depreciation of building, repair and maintenance of the building, rent of building etc. are incurred for the common benefit of more than one department. At this stage, such items are apportioned to benefiting departments.

One best step to apportion overhead expenses is to know the basis of apportionment of overhead expenses and then to use them. There are various basis on which apportionment of overhead over relevant departments can be made. The choice of an appropriate basis is really a matter of judgment. By using the appropriate basis all overhead will be apportioned to relevant production departments and service departments.

Example

Suppose total rent is $5000
Area of department A is 100 square feet.
Area of department B is 200 square feet.
Area of department C is 700 square feet,

Now the total ratio of A : B : C is 1 : 2 : 7

Total rent expenses of department A = (5,000) x 1/10 = $500

Total rent expenses of department B = (5,000) x 2/10 = $1,000

Total rent expenses of department C = (5,000) x 7/10 = $3,500

Total Rent = $5,000

From the above example, it is clear total overhead cost will be apportioned to different departments on some basis. The basis of rent apportionment is the area of the department.

2. Secondary Apportionment

The secondary apportionment stage reapportions service department overhead to production departments. The objective of this stage is to ensure that only production departments bear all overhead costs, and which will eventually be charged to products.

Such reapportionment is necessary for calculating predetermined overhead absorption rates for production departments through which overhead is assigned to products. The basis for secondary apportionment is also the value of benefit derived.

Example

We have a store department (which is a service department). Its store service cost is $1,000. production department A has consumed 4000 units, Production department B has consumed units. So. store service department cost will be reapportioned on the basis of material consumed by different departments.

Department A’s store service cost = 1,000 x 4/10 = $400

Department B’s store service cost = 1,000 x 6/10 = $600

Here, total materials consumed are = 4,000 + 6,000 = 10,000

So the above ratio is calculated as:

Dpeartment A = 4,000 / 10,000 = 4/10

Department B = 6,000 / 10,000 = 6/10

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