Re-Apportionment of Overheads: Definition, Methods, and Importance in Cost AccountingIn cost accounting, overhead costs are indirect expenses incurred in the production process. These costs cannot be traced directly to a single product or department. Instead, they must be distributed across various departments. After the initial allocation and apportionment of overheads, companies perform a process known as the re-apportionment of overheads. This process ensures that service department overheads are redistributed to production departments to reflect accurate costs.
In this topic, we will explain the meaning of re-apportionment of overheads, its importance, common methods, and the role it plays in business decision-making.
What is Re-Apportionment of Overheads?
Re-apportionment of overheads refers to the redistribution of costs from service departments to production departments. Service departments, such as maintenance, security, and human resources, do not produce goods directly. However, they support the production departments. As a result, their costs are ultimately transferred to the production departments, which are directly responsible for manufacturing products.
This process helps in determining the correct cost per unit of production and ensures accurate pricing and profitability analysis.
Importance of Re-Apportionment of Overheads
1. Accurate Costing
Without re-apportionment, the costs of service departments would not be reflected in product pricing. Proper redistribution ensures that all indirect expenses are accounted for.
2. Informed Decision-Making
Knowing the true cost of production helps management make pricing, budgeting, and cost-control decisions with confidence.
3. Fair Distribution of Costs
It ensures that no production department carries an unfair burden of overhead expenses. Each department absorbs its fair share based on usage.
4. Improved Profitability Analysis
By incorporating service department costs into production costs, companies can better analyze product profitability and departmental efficiency.
Methods of Re-Apportionment of Overheads
There are several methods used for re-apportionment of overheads. The choice depends on the size of the organization, the complexity of operations, and management preferences.
1. Direct Method
The direct method allocates the costs of service departments directly to the production departments based on predetermined percentages or usage. This method ignores services rendered between service departments.
Example:
If the maintenance department’s overhead is $10,000 and 60% of its services are used by Department A and 40% by Department B, $6,000 and $4,000 are directly allocated.
2. Step-Down Method
Also known as the sequential method, the step-down method first allocates one service department’s costs to all other departments (both service and production). The process continues sequentially until all service department costs are fully re-apportioned.
Example:
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Start with the service department that serves the most departments.
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Allocate its costs to other service and production departments.
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Move on to the next service department, now including the re-apportioned amount.
3. Reciprocal Method
The reciprocal method accounts for mutual services between service departments. It uses simultaneous equations to calculate accurate allocations. This method is the most precise but also the most complex.
Example:
- If Maintenance serves HR and HR also serves Maintenance, their overheads are calculated using mathematical equations before final allocation to production departments.
Factors to Consider in Re-Apportionment
1. Basis of Apportionment
Choosing the right basis is critical. Common bases include:
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Floor area occupied (for rent)
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Machine hours (for maintenance)
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Number of employees (for HR or canteen costs)
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Power consumption (for electricity costs)
2. Nature of Services
Understanding how each service department supports production departments helps choose the right method of re-apportionment.
3. Inter-Service Department Usage
Some departments provide services to each other. Recognizing this is essential for accurate cost distribution.
Advantages of Re-Apportionment of Overheads
Accurate Product Pricing
Products are priced accurately when all overheads are fairly distributed, preventing underpricing or overpricing.
Budgeting and Planning
Clear cost distribution helps management create realistic budgets and forecast future expenses.
Cost Control
Departments can analyze overhead absorption rates and control excessive indirect expenses.
Profitability Tracking
Proper re-apportionment allows companies to track which products or departments are most profitable.
Challenges in Re-Apportionment of Overheads
Complexity in Large Organizations
The bigger the business, the more complex the process of redistributing service department costs.
Difficulty in Choosing the Right Basis
Selecting the wrong apportionment base can distort costs and lead to incorrect decisions.
Time-Consuming
If done manually or without proper software, re-apportionment can be a time-consuming process.
Best Practices for Re-Apportionment of Overheads
Use of Cost Accounting Software
Modern software automates complex re-apportionment calculations and reduces errors.
Regular Review of Apportionment Bases
Reassessing bases for apportionment ensures that they remain relevant to operational changes.
Clear Documentation
Maintain records of how costs were apportioned for transparency and future reference.
Staff Training
Ensuring that accounting staff understands the principles of overhead re-apportionment helps avoid mistakes.
Example of Re-Apportionment
Imagine a company with two production departments (A and B) and two service departments (Maintenance and HR).
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Maintenance costs: $20,000
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HR costs: $10,000
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Maintenance allocates 70% of its costs to Department A, 30% to Department B.
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HR allocates 60% of its costs to Department A, 40% to Department B.
Step 1: Allocate Maintenance costs:
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Department A gets $14,000
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Department B gets $6,000
Step 2: Allocate HR costs:
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Department A gets $6,000
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Department B gets $4,000
In total, Department A’s overhead increases by $20,000 and Department B’s by $10,000. This amount is then included in product cost calculations.
The re-apportionment of overheads is a crucial part of cost accounting. By redistributing service department costs to production departments, businesses can determine accurate product costs and make smarter financial decisions. Whether using the direct, step-down, or reciprocal method, this process ensures that each department carries its fair share of expenses.
When done correctly, re-apportionment leads to better budgeting, improved cost control, and enhanced profitability. In today’s competitive business environment, understanding and implementing proper re-apportionment of overheads is essential for sustainable success.