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Allocation and Apportionment of

Overhead costs
Abhay Kumar

Apportionment of Overhead costs


Supporting (Service) Department provides
the services that assist other internal
departments in the company
Operating (Production) Department directly
adds value to a product or service

Apportionment of Overhead costs


Primary Distribution:
Apportionment of Overhead costs to different
departments (Production and service both)
Secondary Distribution
Apportionment of service departments Overhead
costs to Productiondepartment.

Methods to Allocate
Support Department Costs
Single-rate method allocates costs in
each cost pool (service department) to
cost objects (production departments)
using the same rate per unit of a single
allocation base
No distinction is made between fixed
and variable costs in this method

Methods to Allocate
Support Department Costs
Dual-Rate method segregates costs
within each cost pool into two segments:
a variable-cost pool and a fixed-cost pool.
Each pool uses a different cost-allocation
base

Allocation Method Tradeoffs


Single-Rate method is simple to implement,
but treats fixed costs in a manner similar to
variable costs
Dual-Rate method treats fixed and variable
costs more realistically, but is more complex to
implement

Allocation of
Support Department Costs

Methods of Allocating Support Costs


to Production Departments
1.
2.
3.
4.

Direct
Step-Down
Reciprocal
Simultaneous equation

Direct Method
Allocates support costs only to Operating
departments
No Interaction between Support Departments
prior to allocation

Direct Method
Support Departments

Production Departments

Information Systems

Manufacturing

Packaging

Accounting

Cost Allocation -Illustrations

Direct Method

Direct Method

Step-Down Method
Allocates support costs to other support
departments and to operating departments
that partially recognizes the mutual services
provided among all support departments
One-Way Interaction between Support
Departments prior to allocation

Step-Down Method
Support Departments

Production Departments

Information Systems

Manufacturing

Packaging

Accounting

Step-Down Method

Step-Down Method

Reciprocal Method
Allocates support department costs to
operating departments by fully recognizing
the mutual services provided among all
support departments
Full Two-Way Interaction between Support
Departments prior to allocation

Reciprocal Method
Support Departments

Production Departments

Information Systems

Manufacturing

Packaging

Accounting

Reciprocal Method

Reciprocal Method

Illustration -Allocation of cost


Support Department

Total

Maintenance

Facility Mgt
12,60,000 12,60,000
Cost
Human
240,000
Resource Cost
square
27000
footage
Employees in
production

HR Deptt.

Operating Department

Processing

Assembly

15000

3000

16

64

240,000
9000

Allocation of cost
Facilities management cost = $1,260,000
Human resources cost = $240,000
Total square footage in production
departments: 15,000 processing + 3,000
assembly = 18,000
Total employees in production departments
16 processing + 64 assembly = 80
Square footage in human resources = 9,000

Direct Method
Facilities management cost allocated to
processing = (15,000 18,000) $1,260,000 =
$1,050,000
Facilities management cost allocated to assembly
= (3,000 18,000) $1,260,000 = $210,000
Human resources cost allocated to processing =
(16 80) $240,000 = $48,000
Human resources cost allocated to assembly =
(64 80) $240,000 = $192,000

Step-Down Method
To human resources: (9 27) $1,260,000 =
$420,000
To processing:(15 27) $1,260,000 = $700,000
To assembly: (3 27) $1,260,000 = $140,000

$240,000 + $420,000 = $660,000


To processing:(16 80) $660,000 = $132,000
To assembly: (64 80) $660,000 = $528,000

Step-Down Method
Processing department

Direct department costs


From facilities management
From Personnel
Total costs

Direct
$1,000,000
1,050,00
48,000
$2,098,000

Step-Down
$1,000,000
700,000
132,000
$1,832,000

Step-Down Method
Assembly department

Direct
Direct department costs
$1,600,000
From facilities management 210,0 00
From personnel
192,000
Total costs
$2,002,000

Step-Down
$1,600,000
140,000
528,000
$2,268,000

Choosing Between Methods


Direct and Step-Down are simple to compute
and understand.
Direct Method is widely used.
Reciprocal method is more accurate to
ascertain cost.

Allocation of Joint Costs


Two conventional ways of allocating joint costs
to products are widely used:
Physical units
Relative sales values
Joint costs include all inputs of material, labor,
and overhead costs that are incurred before
the split-off point.

Allocation of Joint Costs

The physical-units method requires a common


physical unit for measuring the output of each
product.

The joint costs are allocated based on each


products percentage of the total physical units
produced.

Allocation of joint costs should not affect


decisions about the individual products.

Physical units
Relative
sales
values
Dow Chemical produces two chemicals, X and
Y. The joint cost is $100,000. X sells for $.09
per liter and Y for $.06.Production of X & Y is
1000,000 & 500,000 liters respectively.
Allocate the Joint Cost on each product by
Physical units & Relative sales values methods.

Allocation of Joint Costs


Allocation

Liters
X 1,000,000
Y 500,000
1,500,000

Sales Value at

Weighting
of Joint Costs
(10/15)X$100,000 $ 66,667
(5/15)X$100,000
33,333
100,000

Split-off Point
$ 90,000
30,000
120,000

Allocation of Joint Costs


The joint costs are allocated based on each
products sales value as a percentage of the
total sales value at split-off.

Relative-Sales-Value Method
When weighting is based on the sales value of
the individual products, the allocation of a
cost to one product depends upon the sales
value of both products.

Physical units
Relative sales values
Relative Sales
Value at
Spit-off Point

X
Y

Weighting

$ 90,000 (90/120)X$100,000
30,000 (30/120X$100,000
$120,000

Allocation
of Joint Costs
$ 75,000
25,000

By-product Cost
A by-product is not individually identifiable until
manufacturing reaches a split-off point.
They have relatively insignificant sales value.
If an item is accounted for as a by-product, only
separable costs are allocated to it.
All joint costs are allocated to the main products.
Any revenues from by-products, less their
separable costs, are deducted from the cost of
the main products.

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