Here are your brief notes on Allocated and Apportionment of Overheads

After classification of overheads all the items of overheads are collected properly under suitable account heading. The next step is allocation and apportionment of overheads. This is also known as departmentalisation or primary distribution of overheads.

Before discussing allocation and apportionment or departmentalisation of overheads, it is essential to study the different types of departments or cost centers. In a manufacturing concern there can be broadly two categories of departments namely production departments and service departments.

Production Departments:

Production departments are those departments where actual process of manufacturing is carried on. For example in a cotton textile mill, spinning, weaving and finishing departments are production departments. In the production departments, with the help of manual and or machine operations the raw materials are converted to finished goods.

Example: In steel, rolling mill, hot mill, cold mill, polishing, grinding are the production departments.

Service Departments:

Service departments are auxiliary and are those departments which are not directly engaged in production. These departments are essential for smooth and efficient running of production departments. Such departments render services such as repairs, maintenance, electricity, etc. for the benefit of other departments.

Example: Stores, cost office, personnel dept. labour welfare dept., canteen, time keeping, repairs and maintenance, tool room, hospital etc.

A department may be either production department or service department depending upon the nature and function. But there are some service departments which occasionally engaged in production apart from rendering services.

These are called partly producing departments. For example, a carpentry unit which does repairs of furniture and fittings may be engaged to manufacture packing boxes. In such case it will be a partly producing department.

Allocation Of Overhead

Allocation of overheads is the process of charging whole amount of an individual item of cost directly to the cost center or department. An expense which is directly identifiable with a specific cost center is allocated to that cost center.

For example when separate electric meters are installed in different departments, the electricity charges basing on the electricity bills can be allocated to respective departments. Rent of canteen building is allocated to canteen. Similarly the indirect wages of different departments can be directly allocated to the respective departments.

Apportionment Of Overhead

Apportionment of overheads is the process of charging the proportion of common items of cost to different cost centers. When whole of one item of cost cannot be identified wholly with a particular cost center or department, such expense requires division or apportionment over two or more cost centers.

These overhead items are known as common costs or omnibus expenses. While dividing the common cost among two or more departments, a suitable or rational basis is considered. For example, the whole of factory rent needs to be apportioned among various departments on the basis of floor area occupied by respective departments.

Similarly when there is one electric meter in the factory, the common electricity charges should be apportioned to various departments on the basis of the light points or floor area.

Guidelines of Apportionment:

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 item 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. For example, rent can be apportioned on the basis of floor area occupied by each department.

2. Potential Benefit:

According to this principle, the apportionment of 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. For example, the cost of canteen can be apportioned as the basis of number of employees in each department which is a potential benefit.

3. Ability to pay:

According to this method, overheads should be apportioned on the basis of the sales ability 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 overheads 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. For example, while apportioning salary of 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.