MANUFACTURING OVERHEAD – DEPARTMENTALIZATION

Departmentalization of factory overhead means dividing the plant into segments called “departments”
or “cost centers” to which expenses are charged. Accounting wise, the main reasons for dividing a plant
into separate departments are:
1. More accurate costing of jobs and products and
2. More responsible control of overhead costs.

DEPARTMENTS INVOLVED:
1. Producing Department
- Directly deals with the manufacturing of the products
2. Service Department
- Deals with services that indirectly assist/support the producing department

*Costs from the service department are allocated to the producing department

METHODS OF ALLOCATING SERVICE COST TO PRODUCING DEPARTMENT

1. Direct Method
- Most widely used method
- Ignores any service rendered by another service department
- Allocates each service department’s total cost directly to the producing departments

2. Step / Step down Method

- Recognizes services rendered by other service departments
- Sequential basis of allocation:
a. Allocation starts with the department that renders the service to the greatest
number of departments
b. If two or more service departments renders to the same number of departments,
select the department with the highest cost
c. Once a service has allocated its cost, no other service cost may be allocated to it.
 3. Alegebraic / Reciprocal Method
- Allocates cost by including the mutual services rendered among all departments
- Uses algebraic equations to give a more precise allocation to producing departments.

EXAMPLE:

The Val Company has two service departments and two producing departments. The following are the
overhead costs of each department:

Service Department:
Factory Administration P 129,000
Building and Grounds 105,000
Producing Department:
Machinery P 416,000
Assembly 380,000

Additional Information:
Department Estimated Labor Hours Square Footage
Factory Administration 2900 1200
Building and Grounds 1100 1500
Machinery 2000 1900
Assembly 1600 3200

The costs of factory administration are allocated based on estimated labor hours; building and grounds
are allocated based on square footage. The producing department uses machine hours, with 30,000 for
machinery and 22,800 for assembly.

SOLUTION:

Direct Method
DL Hours % Square Footage %
Machinery 2,000 55.56 1,900 37.25
Assembly 1,600 44.44 3,200 62.75
3,600 100.00 5,100 100.00
 Allocation:
Machinery Assembly
Factory Administration:
P129,000 x 55.56% P7 1,672
P129,000 x 44.44% P 57,328
Building and grounds:
P105,000 x 37.25% 39,113
P105,000 x 62.75% 65,888
Total P110,785 P123,216

Total costs after allocation:

Machinery: P416,000 + P110,785 = P526,785
Assembly: P380,000 + P123,216 = P503,216

Factory overhead rates (based on machine hours):

Machinery: P526,785 / 30,000 = P17.56 per hour.
Assembly: P503,216 / 22,800 = P22.07 per hour

Step Down Method

Factory Administration (P129,000):

Base % Allocation
Building and Grounds 1,100 23.41 P 30,199
Machinery 2,000 42.55 54,890
Assembly 1,600 34.04 43,911
Total 4,700 100.00 P129,000

Building and grounds (P105,000 + P30,199 = P135,199):

Base % Allocation
Machinery 1,900 37.25 P 50,362
Assembly 3,200 62.75 84,837
Total 5,100 100.00 P135,199

Total costs after allocation:

Machinery: P416,000 + P54,890 + P50,362 = P521,252
Assembly: P380,000 + P43.911 + P84,837 = P508,748

Factory overhead rates (based on machine hours):

Machinery: P521,252 / 30,000 = P17.38 per hour
Assembly: P508,748 / 22,800 = P22.31 per hour
Reciprocal Method
Factory Building and
Adm. % Grounds %
Factory adm. (F) n/a n/a 1,200 .19
Building grounds (B) 1,100 .23 n/a n/a
Machinery 2,000 .43 1,900 .30
Assembly 1,600 .34 3,200 .51

Equation:
F = P129,000 + .19B
B = P105,000 + .23F

F = P129,000 + .19 (P105,000 + .23F)

F = P129,000 + P19,950 + .0437F
.9563F = P148,950
F = P155,757

B = P105,000 + .23(P155,757)
B = P105,000 + P35,824
B = P140,824

Cost Allocations:
Factory Administration allocations:
Building and grounds: P155,757 x .23 = P35,824
Machinery: P155,757 x .43 = P66,976
Assembly: P155,757 x .34 = P52,957

Building and Grounds allocations:

Factory administration: P140,824 x .19 = P26,757
Machinery: P140,824 x .30 = P42,247
Assembly: P140,824 x .51 = P71,820

Total cost after allocations:

Building &
F. Admin. Grounds Machinery Assembly
Direct cost P129,000 P105,000 P416,000 P380,000
F. Administration (155,757) 35,824 66,976 52,957
Bldg. and Grounds 26,757 (140,824) 42,247 71,820
Total P 0 P 0 P525,223 P504,777
F/O rates P17.51 P22.14
ANOTHER EXAMPLE:

Pomelo Company has two service departments (1 and 2) and two operating (producing) departments (A
and B). Data provided are as follows:

Service Departments Operating Departments

1 2 A B
Direct Costs P 150 P 300 P 5,000 P 6,000
Services performed by:
Department 1 40% 40% 20%
Services performed by:
Department 2 20% 70% 10%

SOLUTIONS:

Direct Method

Service Departments Operating Departments

1 2 A B
Direct Costs P 150 P 300
Allocation of
Department 1 cost (1) 100 (2) 50
Allocation of
Department 2 cost (3) 262.50 (4) 37.50
Cost allocated to A &B P 362.50 P 87.50
Direct Costs 5,000 6,000
Total Overhead P 5,362.50 P 6,087.50

(1). 150 x (40/60) = 100

(2) 150 x (20/60) = 50
(3) 300 x (70/80) = 262.50
(4) 300 x (10/80) = 37.50

Step Method

Service Departments Operating Departments

1 2 A B
Direct Costs P 150 P 300
Allocation of
Department 2 cost 60 (300) 210 30
(20:70:10)
Allocation of
Department 1 cost (210) - 140 70
(40:20)
Cost allocated to A & B - - P350 P100
 Direct Costs 5,000 6,000
Total Overhead P 5,350 P 6,100

Algebraic Method

Step 1: Find the equation. Let D1 be the total cost of Dept 1 and let D2 be the total cost of Dept 2
D1 = 150 + 0.2D2
D2 = 300 + 0.4D1

Step 2: Use substitution method

D1 = 150 + [.20(300+0.4D1)] Substitute to D2:
D1 = 150 +60 + 0.8D1 D2 = 300 + 0.4(228.26)
.92D1 = 210 D2 = 300 + 91.30
D1 = P228.26 D2 = P391.30

Step 3: Allocate the complete costs of each service department to all other departments (both service
and operating departments)

Service Departments Operating Departments

1 2 A B
Direct Costs P 150 P 300
Allocation of
Department 1 cost (228.26) 91.30 91.30 45.65
(40:40:20)
Allocation of
Department 2 cost 78.26 (391.30) 273.91 39.13
(20:70:10)
Cost allocated to A & B - - P365.21 P84.78
Direct Costs 5,000 6,000
Total Overhead P 5,365.21 P 6,084.78

Additional Notes:
1. When there are different allocation bases for different service departments. Use the allocation base