FACTORY OVERHEADS

ALLOCATION &
DISTRIBUTION
 Cost Assignment
• The general term cost assignment refers to
both tracing direct costs and allocating
indirect costs to cost objects.
Direct Cost
materials and Tracing
Cost direct labor Cost
Assigned Object
Cost (Job)
FACTORY
Allocation
overhead
Factory Overhead Costs All manufacturing costs not
classified as direct materials or
Manufacturing direct labor.
overhead 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.
 What is Allocation
1
• Cost of manufacturing overhead needs to be allocated
to various jobs in production. It is NOT a direct cost.

• 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
 Why Allocation

Objectives

• 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.
 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
 Steps in Allocating Support Costs
•First Step in Cost Allocation…..determine what the cost objects are!!!!!
• Usually the cost objects are departments
• Two types: producing and support
Provide support Service departments provide essential
that facilitates the support for production departments
activities of production (power house, canteen, repairs &
departments. maintenance)

Producing departments are directly

Carry out the responsible for the creation of goods
central purposes or services sold to customers
of an organization. Textile Industry: carding, spinning,
weaving, dyeing, finishing

Goods and Services

Corporate Examples
Corporate Examples
 Steps in Allocating Support Costs
•First Step in Cost Allocation…..determine what the cost objects are!!!!!
• OVERHEAD EXPENDITURE ESTIMATION (DONE FOR ALL FACTORY)
– FIXED (MGT SALARY, DEP, RENT & TAXES)
– SEMI VARIABLE ( INURANCE PREMIUM)
– VARIABLE ( REPAIRS, INDIRECT LABOUR)

● 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

Organization
producing departments
Calculate predetermined overhead rates
The

●
for producing departments
● Allocate overhead costs to units of
individual products through the
predetermined overhead rates
 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
PRIMARY DISTRIBUTION
Stage I
Total Indirect Costs
Rs1,550

Service Rs100
Departments Rs50 Rs200

Production
Departments Rs300 Rs400 Rs500
 Two-Stage Cost Allocation
Stage I SECONDARY DISTRIBUTION
Service department costs are allocated
to production departments.
Service
Departments Rs50 Rs100 Rs200

Production Rs425 Rs550 Rs575

Departments
 Two-Stage Cost Allocation
Production department costs are allocated to
Stage II
jobs and products.

Production
Rs 425 Rs550 Rs575
Departments

Job 1 Job 2 Job 3

 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
When selecting a cost
•SPACE - FOR FACTORY RENT, PROPERTY TAXES driver consider:
•LABOUR - FOR WAGE, EMPLOYEE WELFARE EXP • The ease of obtaining
data.
•ACTIVITY - FOR ELECTRICITY, POWER, DEP • The degree to which the
cost driver measures
actual consumption by
products.
 STAGE -I FACTORY OVERHEAD ALLOCATION
• APPORTIONMENT (PRIMARY DISTRIBUTION)
– RESULTS IN COLLECTION OF TOTAL FACTORY OVERHEADS
UNDER VARIOUS PRODUCTION COST CENTRES
• WE GET TOTAL FACTORY OVERHEAD FOR EACH COST CENTRE

P r im a r y d is tr ib u tio n s u m m a r y
Ite m o f C o s t B a s is o f T o ta l P 1 P2 P3 S1 S2
a p p o rtio n m e n(Rt s)
R e n t & ra te F lo o r a re a 5 0 0 0 1 0 0 0 1 2 5 0 1 5 0 0 1 0 0 0 250
G e n e ra l L ig h tinLgig h t P o in ts 6 0 0 1 0 0 1 5 0 2 0 0 1 0 0 50
In d ire c t W a g eDs i re c t W a g e s1 9 3 9 6 0 0 4 0 0 6 0 0 3 0 0 39
Power H o rs e P o w e r1 5 0 0 6 0 0 3 0 0 5 0 0 1 0 0 0
D e p re c i a tioVn a lu e o f m a c h1in0 e0 0 0 2 4 0 0 3 2 0 0 4 0 0 0 2 0 0 200
S u n d rie s D i re c t W a g e s9 6 9 5 3 0 0 0 2 0 0 0 3 0 0 0 1 5 0 0 195
T o ta l 28734 7700 7300 9800 3200 734
 STAGE -I FACTORY OVERHEAD ALLOCATION
• APPORTIONMENT (PRIMARY DISTRIBUTION)
– RESULTS IN ALLOCATION & APPORTIONMENT OF TOTAL
FACTORY OVERHEADS UNDER VARIOUS SERVICE COST
CENTRES

Primary distribution summary

Item of Cost Basis of Total P1 P2 P3 S1 S2
apportionment (Rs)
Rent & rate Floor area 5000 1000 1250 1500 1000 250
General Lighting Light Points 600 100 150 200 100 50
Indirect Wages Direct Wages 1939 600 400 600 300 39
Power Horse Power 1500 600 300 500 100 0
Depreciation Value of machine 10000 2400 3200 4000 200 200
Sundries Direct Wages 9695 3000 2000 3000 1500 195
Total 28734 7700 7300 9800 3200 734
 STAGE -I FACTORY OVERHEAD ALLOCATION
• REAPPORTIONMENT (SECONDARY DISTRIBUTION)
– RESULTS IN ALLOCATION & APPORTIONMENT OF TOTAL
FACTORY OVERHEADS UNDER VARIOUS SERVICE COST
CENTRES
• THIS NEEDS TO BE REAPPORTIONED SO THAT THE TOTAL
FACTORY OVERHEADS ARE COLLECTED UNDER PRODUCTION
COST CENTRES ONLY (EASILY DONE)

Primary distribution summary

Item of Cost Basis of Total P1 P2 P3 S1 S2
apportionment (Rs)
Rent & rate Floor area 5000 1000 1250 1500 1000 250
General Lighting Light Points 600 100 150 200 100 50
Indirect Wages Direct Wages 1939 600 400 600 300 39
Power Horse Power 1500 600 300 500 100 0
Depreciation Value of machine 10000 2400 3200 4000 200 200
Sundries Direct Wages 9695 3000 2000 3000 1500 195
Total 28734 7700 7300 9800 3200 734
 STAGE -I FACTORY OVERHEAD ALLOCATION
• REAPPORTIONMENT (SECONDARY DISTRIBUTION)
– RESULTS IN ALLOCATION & APPORTIONMENT OF TOTAL
FACTORY OVERHEADS UNDER VARIOUS SERVICE COST
CENTRES
• 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
– RESULTS IN ALLOCATION & APPORTIONMENT OF TOTAL FACTORY
OVERHEADS UNDER VARIOUS SERVICE COST CENTRES
– THIS NEEDS TO BE REAPPORTIONED SO THAT THE TOTAL FACTORY
OVERHEADS ARE COLLECTED UNDER PRODUCTION COST CENTRES ONLY
(EASILY DONE) Direct
Direct
Allocations Method
Method
Allocationsgogodirectly
directlyto
toproduction
production
or direct-service departments. Charges
or direct-service departments. Chargescosts
costsofofsupport-
support-service
service
This
Thismethod
methodignores
ignoresservices departments
services departmentstotointernal
internalcustomers
customers
provided
providedtotoother
othersupport
supportservice without
service withoutmaking
making allocations
allocationsamong
among
departments. service
departments. servicedepartments.
departments.
Primary distribution summary
Item of Cost Basis of Total P1 P2 P3 S1 S2
apportionment (Rs)
Rent & rate Floor area 5000 1000 1250 1500 1000 250
General Lighting Light Points 600 100 150 200 100 50
Indirect Wages Direct Wages 1939 600 400 600 300 39
Power Horse Power 1500 600 300 500 100 0
Depreciation Value of machine 10000 2400 3200 4000 200 200
Sundries Direct Wages 9695 3000 2000 3000 1500 195
Total 28734 7700 7300 9800 3200 734
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
Step
Step
Method
Method
Recognizes
Recognizesthatthatsome
somesupport-
support- Allocations
Allocationsbegin
beginwith
withthe
the
service
servicedepartments
departmentsprovide
provide service
servicedepartment
departmentwith
withthe
the
services
servicesto
toother
othersupport
support largest
largestproportion
proportionof
ofits
itstotal
total
services
servicesasaswell
wellas
asproduction
production allocation
allocationbase
basein
inother
otherservice
service
and
anddirect
directservice
servicedepartments
departments departments
departments
STAGE -I FACTORY OVERHEAD ALLOCATION
• REAPPORTIONMENT
(SECONDARY
DISTRIBUTION) STEP
STAGE -I FACTORY OVERHEAD ALLOCATION
• REAPPORTIONMENT
(SECONDARY
DISTRIBUTION) STEP
 STAGE -I FACTORY OVERHEAD ALLOCATION
• REAPPORTIONMENT (SECONDARY DISTRIBUTION)
– RESULTS IN ALLOCATION & APPORTIONMENT OF TOTAL
FACTORY OVERHEADS UNDER VARIOUS SERVICE COST
CENTRES
• 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

Primary distribution summary

Item of Cost Basis of Total P1 P2 P3 S1 S2
apportionment (Rs)
Rent & rate Floor area 5000 1000 1250 1500 1000 250
General Lighting Light Points 600 100 150 200 100 50
Indirect Wages Direct Wages 1939 600 400 600 300 39
Power Horse Power 1500 600 300 500 100 0
Depreciation Value of machine 10000 2400 3200 4000 200 200
Sundries Direct Wages 9695 3000 2000 3000 1500 195
Total 28734 7700 7300 9800 3200 734
 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

S e c o n d a ry D is trib u tio n S u m m a ry
P a rtic u la rs P1 P2 P3 S1 S2
T o ta l O ve rh e a d 7700 7300 9800 3200 734
O ve rh e a d o f S 1 (2 0 :3 0 :4 0 :1 0 ) 6 4 0 9 6 0 1 2 8 0 -3 2 0 0 3 2 0
O ve rh e a d o f S 2 (4 0 :2 0 :3 0 :1 0 ) 4 2 2 2 1 1 3 1 6 1 0 5 -1 0 5 4
O ve rh e a d o f S 1 (2 0 :3 0 :4 0 :1 0 ) 21 32 4 2 -1 0 5 10
O ve rh e a d o f S 2 (4 0 :2 0 :3 0 :1 0 ) 4 2 3 1 -1 0
O ve rh e a d o f S 1 (2 0 :3 0 :4 0 :1 0 ) 1 -1
TO TA L 8787 8505 11442 0 0
 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
Examples of Cost Drivers for
• VALUE OF INVENTORY Support Departments
• TOTAL COST OF BUSINESS FIRMS Support Department Possible Driver
• DETERMINING PRICE OF PRODUCT/JOB
Accoun ting Number of transactions

– GENERAL BASIS Cafeteria Number of em ployees

• PROPORTIONATE BENEFIT DERIVED En gineering Nu mber of change orders
BY VARIOUS COST CENTRES Maintenance Mach ine h ours
– WE USE Payroll Number of em ployees
• REPEATED DISTRIBUTION METHOD Personn el Number of new hires
 Determine if the Cost Allocations Achieve
Desired Results
COST
COSTALLOCATION
ALLOCATIONEFFECTS
EFFECTS
IfIfsupport-service
support-servicedepartments
departmentsprovide
providesignificant
significantservices
servicesto
toeach
each
other,
other,the
theamounts
amountsofofcosts
costsallocated
allocatedto
todirect-service,
direct-service,production,
production,
and
andmarketing
marketingdepartments
departmentsprobably
probablydiffer
differunder
undereach
eachmethod.
method.

Significant
Significant
differences
differences
can
caneffect:
effect:
Performance
Performance Contracts
Contracts
evaluations
evaluations
Decision-
Decision-
making
making
10-30
 Determine if the Cost Allocations Achieve
Desired Results
COST
COSTALLOCATION
ALLOCATIONCOSTS
COSTSAND
ANDBENEFITS
BENEFITS

Complex
Complexcost-allocation
cost-allocation Complex
Complexcost-allocation
cost-allocation
systems
systemsare
aredifficult
difficult systems
systemsare
aredifficult
difficult
and
andcostly
costlyto
toDESIGN
DESIGN and
andcostly
costlyto
toMAINTAIN
MAINTAIN

Cost-allocation
Cost-allocationsystems
systemsmay mayrequire
requirerevision
revision in
in aa
continual
continual process
processof ofimprovement,
improvement, which
which isiscostly
costlybutbut
can
canbe
bejustified
justifiedifif decisions
decisions and
and organizational
organizational
performance
performance also also continue
continuetoto improve.
improve.
10-31
 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