Cost Allocation and Apportionment Cost Allocation: Certain items of overhead costs can be directly identified with a particular

department or cost centre as having been incurred for that cost centre. Allotment of such costs to departments or cost centres is known as allocation. Thus, allocation may be defined as “the allotment of whole items of cost centres or cost units.” A point to be understood is that allocation can be made only when exact amount of overheads that result solely from the existence of that cost centre. In brief, in order that an overhead can be allocated , it should meet both of the following conditions: (a) The cost centre must have caused the overhead to be incurred. (b) The exact amount incurred in a cost centre must be known. Apportionment: Certain overhead costs cannot be directly charged to a department or cost centre. Such costs are common to a number of cost centres or departments and do not originate from any specific department. Distribution of such overhead costs to various departments is known as apportionment.

Thus, apportionment may be defined as “the allotment of proportions of items of cost centres or cost units.” Difference between Cost Allocation and Apportionment Cost Allocation 1. Deals with whole items of costs. 2. Is a direct Process 3. Cost allocation depends upon the nature of cost. Apportionment 1. Deals with proportions of items of cost. 2. Is a Indirect Process for which suitable bases are to be selected. 3. Apportionment does not depend upon the nature of cost.

Apportionment on Reciprocal Basis: This method is used when service departments are mutually dependent. This means a service department not only provides its services to other service departments but also receives services of other services departments.

The following methods may be used for apportionment of overhead costs on a reciprocal basis: 1. Simultaneous Equation Method 2. Repeated Distribution Method 3. Trial and Error Method 1. Simultaneous Equation Method In this method, the following algebraic equations help in finding out cost of service departments. Illustration 1. A company has three production departments and two service departments. Distribution summary of overheads is as follows: Production Departments Service Departments A B C Rs.3,000 Rs.2,000 Rs.1,000 1. 2. Rs.234 Rs.300

The expenses of service departments are charged on a percentage basis which is as follows: 1. 2. A 20% 40% B 40% 20% C 30% 20% 1 20% 2 10% -

Find out the total overheads of production departments using the following methods: A) Simultaneous Equations Method B) Repeated Distribution Method Simultaneous Equations Method Let x denotes total overhead of service department 1 y denotes total overhead of service department 2 Therefore, x = 234 + 0.2y………………1 y = 300 + 0.1x ……………...2 x – 0.2y = 234……………1 - 0.1x + y = 300……………..2 To solve the equations, re-arrange these and multiply by 10 to eliminate decimals. 10x – 2y = 2,340……………..1 - x + 10y = 3,000……………..2 Multiplying second equation by 10 and adding 10x – 2y = 2,340 -10x + 100y = 30,000 98y = 32,340 y= 32,340 ÷ 98 y = 330 x = 300

Secondary Distribution Summary Production Departments Total A B C Total as per 6,000 3,000 2,000 1,000 primary summary Service Dept. 1 270 60 120 90 (90% of 300) Service Dept. 2 264 132 66 66 (80% of 330) Total 6534 3192 2186 1156

b) Repeated Distribution Method

Production Departments Items Total as per primary summary Service Dept.1 Service Dept.2 Service Dept.1 Service Dept.2 Total A 3,000 B 2,000 C 1,000

Service Departments X 234 Y 300

47 129 13 2 3,191

94 65 26 2 2,187

70 65 19 2 1,156

-234 64 -64 -

23 -323 6 -

Illustration 2. The following particulars relate to ADM Manufacturing Company which has three production departments A, B, C and two service departments X and Y. Total overheads as per primary distribution A 6,300 B C DEPARTMENTS X 7,400 2,800 4,500 Y 2,000

The company decided to apportion the service department costs on the following percentages: A B C X Y X 40% 30% 20% 10% Y 30% 30% 20% 20% Find the total overheads of production departments using simultaneous equations method.

Trial and Error Method: In this method the cost of first service department is apportioned to other service departments only in the given percentage. The cost of the second service departments then is

apportioned to the first and other service departments. In this way, when the cost of all service departments has been apportioned, the process is repeated till the service departments costs are reduced to negligible amounts. In this way, the total cost of each service department is found out by trial and error. Apportionment on Non- Reciprocal basis (Step Ladder Method) This method is used when a service department renders services to other service departments but does not receive services of the other service departments, ie. when service departments are not inter-dependent. In this method, the service departments are arranged in descending order of their serviceability. The service department which serves the next largest number of departments is taken up next and its cost is apportioned to other service and production departments excepting the first service department. This process is continued till the cost of the last service department is apportioned. Illustration 3 A factory has three production departments A, B, and C and two service departments P and Q. The overhead

departmental distribution following: Production Departments

summary

shows

the

Service Departments

A B C

Rs. 6,50,000 P Rs. 6,00,000 Q Rs. 5,00,000

Rs. 1,20,000 Rs. 1,00,000

The service department expenses are allotted on a percentage basis as follows: Production Dept. A B C Service Dept. P Service Dept. Q 30% 40% 40% 30% 15% 25% Service Dept. P Q 5% 15% -

Show how the expenses of the service departments are to be charged to production departments using Simultaneous Equation Method and Repeated Distribution Method.

Illustration No. 4

A Company has three production departments and two service departments. Distribution Summary of overheads is as follows: Production Dept. Service Dept. A B C 13,600 14,700 12,800 X 9,000 Y 3,000

Total overheads as per primary distribution

The expenses of service departments are charged on a percentage basis which is as follows:

Service Dept. X Service Dept. Y

Production Dept. Service Dept. A B C X Y 40% 30% 20% 10% 30% 30% 20% 20% -

Apportion the cost of service departments by using the Simultaneous Equation Method and Repeated Distribution Method.

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