Chapter 13

Factory Overhead -
Departmentalization
Discussant: Pangilinan, Kyla Mae C.
Learning Objectives
After studying this chapter, you will be able to:
1.Describe the concept of Departmentalization
2.Distinguish between service and producing departments.
3.Define direct and indirect departmental costs and give
example each.
4.Compute and use departmental overhead rates.
5.Accumulate actual departmental overhead costs.
6.Describe departmentalization in nonmanufacturing and non-
profit organization.
Table of contents

01 02
Producing and Service Departments
Departmentalization
I. Selection of Producing Departments
II. Selection of Service Departments

03 04
Direct Departmental Costs
I. Supervision, Indirect Labor and Overtime
II. Labor Fringe Benefit
Indirect Departmental Cost
III. Indirect Materials and Supplies
IV. Repairs and Maintenance
V. Equipment Depreciation
01 Departmentalization
What is Departmentalization?

Departmentalization of factory overhead means dividing

the plant into segments, called departments, to which
overhead costs are charged. For accounting purposes, dividing
a plant into separate departments provides improved product
costing and promotes responsible control of overhead costs.
Benefits of Departmentalization

1. Provides improved product costing and promote responsible control of

overhead costs.
2. Allows different departments to have different overhead rates.
3. The plantwide average rate may be too high or too low for a particular product,
especially a product involving only one or a few departments.
4. Departmentalization facilitates responsibility accounting and control of
overhead costs by making costs a responsibility of each department’s manager.
 02
Producing and Service
Departments
I. Selection of Producing
Departments
II. Selection of Service Departments
 Producing and Service Departments
Departments are classified as either producing or service
departments. A producing department manufactures the
product by changing the form or material or by assembling
parts. A service department renders a service that
contributes in an indirect way to the manufacture of the
product but does not change the form, assembly, or nature of
the material.
Examples of producing and service departments follow:

Producing Service
Cutting Mill Room Utilities Shipping
Planning Plating
Receiving Medical
Assembly Knitting
Upholstery Mixing Inspection Production Control

Finishing Refining Storage Personnel

Machining Bottling
Security Maintenance
Cooking Canning
Brewing Glazing Purchasing Cafeteria

Distilling Fabricating Materials Handling General Factory Cost

Pool
I. Selection of Producing Departments
The cost information system is design to reflect the departmentalization. The system accumulates
production costs by department, whether operations are of the job type or the continuous process type.
Factors to be considered in deciding the kinds of departments required for establishing accurate
departmental overhead rates are as follows:
1. Similarity of operations and machinery in each department.
2. Location of the operations and machinery.
3. Responsibilities for production and costs.
4. Relationship of operations to flow of product.
5. Number of departments.
II. Selection of Service Departments
Services that benefit bot producing departments and other service departments can be
organized by
(1) Establishing a separate service department for each function,
(2) combining several functions into one department, or
(3) placing some service costs in a department called general factory cost pool.
The specific service being accounted for is not identified if service costs are accumulated
in a general factory cost pool.
Example
Green Company’s factory contains two producing departments: Assembly and Finishing Department, and two
service departments: Maintenance Department cost is allocated based on square feet, and Administration Department
cost is allocated producing departments only based on the number of employees of the department. Assembly
Department overhead rate is computed based on machine hours while the Finishing Department is based on Direct
Labor Hours. The estimated annual data are as follows:

Assembly Finishing Maintenance Administration

No. of Employees 600 400 160 120

Square Feet 84,000 36,000 16,000 12,000
Machine Hours 100,000 80,000
Direct Labor Hours 120,000 80,000
Overhead Budget 2,080,000 1,600,000 800,000 600,000
Requirements:
1. Determine the predetermined rate of Assembly and Finishing Department.
2. Determine the Applied factory overhead of two producing departments assuming the actual activities below:

Cost Driver Assembly Finishing

Machine Hours 110,000 70,000

Direct Labor Hours 130,000 70,000

3. Determine the under(over) application on each producing department if the actual overhead for Assembly and
Finishing Department are 3,400,000 and 1,700,000 respectively.
 Producing Service

Assembly Finishing Maintenance Administration

Machine Hours Direct Labor Hours Square Feet No. of Employees

No. of Employees 600 400 160 120

Square Feet 84,000 36,000 16,000 12,000

Machine Hours 100,000 80,000

Direct Labor 120,000 80,000

Hours
Overhead Budget 2,080,000 1,600,000 800,000 600,000
  Maintenance Administration Assembly Finishing

Overhead Cost 800,000 600,000 2,080,000 1,600,000

1st Allocation (800,000)   560,000 240,000

 2nd Allocation   (600,000)  360,000  240,000 

Total 0 0 3,000,000 2,080,000

MAINTENANCE SQUARE FEET  

Assembly (84,000/120,000)*800,000 560,000

Finishing (36,000/120,000)*800,000 240,000

    800,000

ADMINISTRATION NO. OF EMPLOYEES  

Assembly (600/1,000)*600,000 360,000

Finishing (400/1,000)*600,000 240,000

    600,000
  Maintenance Administration Assembly Finishing

Overhead Cost 800,000 600,000 2,080,000 1,600,000

1st Allocation (800,000)   560,000 240,000

 2nd Allocation   (600,000)  360,000  240,000 

Total 0 0 3,000,000 2,080,000

Divided by 100,000 MH 80,000 DLH

Predetermined Rate 30 per MH 26 per DLH

Requirements:
1. Determine the predetermined rate of Assembly and Finishing Department.
2. Determine the Applied factory overhead of two producing departments assuming the actual activities below:

Cost Driver Assembly Finishing

Machine Hours 110,000 70,000

Direct Labor Hours 130,000 70,000

3. Determine the under(over) application on each producing department if the actual overhead for Assembly and
Finishing Department are 3,400,000 and 1,700,000 respectively.
   Maintenance Administration Assembly Finishing

Overhead Cost 800,000 600,000 2,080,000 1,600,000

1st Allocation (800,000)   560,000 240,000

 2nd Allocation   (600,000)  360,000  240,000 

Total 0 0 3,000,000 2,080,000

Divided by 100,000 MH 80,000 DLH

Predetermined Rate 30 per MH 26 per DLH

APPLIED FOH Debit Credit

Assembly Department Machine Hours WIP 3,300,000

110,000 MHs*30 3,300,000 Applied FOH 3,300,000

Finishing Department Direct Labor Hours

Debit Credit
70,000DLHs*26 1,820,000
FOH-C 3,400,000
Various Account 3,400,000
UNDER APPLIED 100,000
 Debit Credit
WIP 1,820,000
Applied FOH 1,820,000

Debit Credit
FOH-C 1,700,000
Various Account 1,700,000

Over Applied 120,000

 03
Direct Departmental Costs
I. Supervision, Indirect Labor and Overtime
II. Labor Fringe Benefit
III. Indirect Materials and Supplies
IV. Repairs and Maintenance
V. Equipment Depreciation
Direct Departmental Costs
Factory overhead consists of all production costs not traceable to
specific jobs or products. But in attributing costs to departments, it is
important to keep in mind that departments tend to be relatively large
areas within a company. As a result, many factory overhead costs are
traceable to a specific department; these costs are called direct
departmental costs.
Direct Departmental Costs
The majority of direct departmental overhead costs can be divided into
the following categories:
(1) supervision, indirect labor, and overtime,
(2) labor fringe benefits.
(3) indirect materials and supplies, (4) repairs and
maintenance, and
(5) equipment depreciation and rent. These categories generally
are readily identified with the originating department, whether it is a
producing or service department.
I. Supervision, Indirect Labor, and Overtime
Labor control and accounting, discussed in Chapter 11, are relevant to the first two
categories—supervision, indirect labor, overtime, and the related fringe benefits. Any
plant labor not classified as direct labor is automatically a part of factory overhead.
Because factory overhead is allocated to all products, an incorrect classification causes
direct labor that applies to one product to be allocated to other products as factory
overhead, understating one product's cost and overstating the cost of the others. Deciding
how to classify costs can have an important effect on overhead rates, especially if direct
labor is used as the base for calculating overhead rates.
II. Labor Fringe Benefits
Labor fringe benefits include such costs as vacation and holiday pay, FICA tax, state
and federal unemployment taxes, worker's compensation insurance, pension costs,
hospitalization benefits, and group insurance. In theory, these fringe benefits are
additional labor costs. When they pertain to direct laborers, they should be added to the
direct labor cost. In practice, this approach is often impractical; therefore, these costs that
pertain to direct laborers and all other production workers are generally included in
overhead and become part of the overhead rate.
III. Indirect Materials and Supplies
The materials control, costing, and quantitative models discussed in Chapter 9 are equally
appropriate in dealing with indirect materials and supplies. Incorrectly distinguishing between
direct and indirect materials has the same adverse effect on product costing as failure to
distinguish properly between direct and indirect labor. However, distinguishing between direct
and indirect materials is usually not as difficult. In a production operation, direct materials are
those that are significant in amount and become an integral part of the end product. Indirect
materials, often referred to as supplies, are auxiliary to the processing operations and do not
become an essential part of the end product. If only insignificant amounts of direct materials are
distinguishable, they can be charged to factory overhead as an expedient.
IV. Repairs and Manitenance
It is essential to establish control over repairs and maintenance costs and to devise
effective means for charging maintenance cost to departments receiving the service. Most
repairs and maintenance costs generally are traceable to benefiting departments and often
are classified as direct departmental costs, even though they may originate in a
maintenance department. If practical, all actual maintenance costs should be charged to a
maintenance department, and the department supervisor should be responsible for keeping
costs within budget. However, because maintenance is a service function, its costs
ultimately must be allocated to departments that receive the service.
V. Equipment Depreciation
Depreciation is usually not considered controllable by department supervisors. However,
their use of equipment results in wear and tear which influences maintenance, and in long run it
influences depreciation as well. This is true with respect to all types of depreciable assets
machinery and equipment, buildings. Vehicles, and furniture and fixtures. For effective product
costing and control depreciation is usually identified with the department that uses the assets. so
the cost is charged directly to departments. The recommended method is to compute
depreciation based on the cost of each department's equipment, as recorded in detailed plant
asset records. When no records are available or equipment is used by more than one department,
depreciation is frequently accumulated in the general factory cost pool Equipment rent is
handled similarly
 04
Indirect Departmental Costs

Indirect Departmental Costs
Costs such as power, light, rent,
and depreciation of plant
buildings, when shared by all
departments are not charged
directly to a department. These
costs do not originate with any
specific department. They are
incurred for the benefit of all
departments, so their cost is
allocated among all departments.
Indirect Departmental Costs
CAS 418, which is mandatory only in costing large government contracts, also affords
guidance for more general uses. It deals with accumulating and allocating indirect costs
and requires federal government contractors to identify and describe allocation bases
for all factory overhead, service center, and general and administrative cost pools. The
allocation must be based on one of the following, listed in order of preference:
(1) a resource consumption measure,
(2) an output measure, or
(3) a surrogate that is representative of resources consumed.
Some of the indirect departmental expenses that require allocation among
departments, together with the bases most commonly used, include the
following:

Indirect Departmental Costs Allocation Bases

Building rent ………………………………………………………………….. Square
footage
Property tax ……………………………………………………………………. Square
footage
Depreciation-buildings …………………………………………… Square footage
Fire insurance ………………………………………………………………. Square
footage
Building repairs …………………………………………………………… Square footage
Gas utility ………………………………………………………………………… Square
footage
Superintendence ………………………………………………............ Number of
Employees
Telephone and telegraph …………. Number of Employees or Number of telephones
For example, assume that individual departments can obtain necessary rental space
separately as follows:

Department Cost of Rental Space Obtained Separately

A 500,000
B 500,000
C 250,000
D 50,000
1,300,000
Assume further that the rental space can be provided under a consolidated rental agreement
for a total cost of $1.030,000. Allocation of the aggregate cost on a stand-alone basis yields
the following result:
Aggregate Allocated
Department Cost Allocation Base Aggregate
Cost
A $1,030,000 × $500,000 ÷ $1,300,000 = $396,154

B $1,030,000 × $500,000 ÷ $1,300,000 = $396,154

C $1,030,000 × $250,000 ÷ $1,300,000 = $198,077

D $1,030,000 × $50,000 ÷ $1,300,000 = $39, 615

$1, 030, 000

Thank you!