Manufacturing Overhead Accounting (Departmentalization) PDF

# Manufacturing Overhead - Departmentalization ## What is departmentalization? Departmentalization of factory overhead means dividing the plant into segments called "departments" or "cost centers" to which expenses are charged. ## Reasons for departmentalization - More accurate costing of jobs...

# Manufacturing Overhead - Departmentalization ## What is departmentalization? Departmentalization of factory overhead means dividing the plant into segments called "departments" or "cost centers" to which expenses are charged. ## Reasons for departmentalization - More accurate costing of jobs and products - More responsible control of overhead costs ## How departmentalization works Departmentalization requires the use of different overhead rates for applying manufacturing overhead. A job or product is charged with manufacturing overhead for work done in a particular department based on the department's predetermined overhead rate. ## Types of Departments involved 1. **Producing Department** - Directly deals with the manufacturing of products - Example: assembly, finishing, and packaging department 2. **Service Department** - Deals with services that indirectly assist or support the producing department - Example: purchasing, medical, and maintenance department - Costs from the service department are allocated to the producing department. ## Procedures of Departmentalization 1. Calculate departmental predetermined overhead application rates. 2. Apply the predetermined overhead rates to production on a department basis. 3. Record actual manufacturing overhead costs by departments in the Departmental Overhead Analysis Sheet. ## Calculation of Departmental Overhead Application Rates 1. Prepare a budget of total direct manufacturing overhead costs of producing departments and total direct expenses of service departments expected at the selected activity levels. 2. Conduct a factory survey to determine the bases to be used in allocating indirect manufacturing overhead costs and service department costs. 3. Set up an application rates worksheet to facilitate cost distribution by departments. 4. Enter budgeted costs that can be traced directly to specific departments as direct departmental costs. 5. Allocate budgeted manufacturing overhead costs that cannot be traced to specific departments according to the base selected. 6. Distribute or reallocate budgeted service department's costs to producing departments. 7. Compute departmental predetermined rates by dividing the total budgeted overhead costs charged to each producing department by the base selected. ## Direct Departmental Overhead Costs Direct departmental overhead costs are those that can be easily traced to specific departments. **Examples:** - Repairs and maintenance - maintenance department - Indirect labor - traced to payroll summaries of the department - Indirect materials - traced through materials requisition of the department - Depreciation of equipment - traced to a department using the equipment ## Allocating Indirect Departmental Costs - It is necessary to obtain certain data through a survey of factory facilities and resources as a basis of allocating indirect departmental costs to benefiting and producing departments. - Each department should be charged with its fair share of the costs determined by the benefits it has received. | Indirect Departmental Costs | Distribution Bases | |---|---| | Factory rent | Square footage | | Depreciation - Factory Building | Square footage | | Fire insurance on building | Square footage | | Repairs and maintenance | Square footage | | Telephone | No. of employees or No. of telephone | | Light | Kilowatt hour | | Freight in | Materials used | ## Allocating Service Department Cost - A reasonable base must be used to charge the cost of operating a service department to the producing department being served. - The base to be used must bear a definite relationship to the cost of the services being served. ## Allocating Service Departmental Costs | Service Departments | Allocation Bases | |---|---| | Procurement | Number of orders or cost of materials | | Receiving | Cost of materials; number of units; number of orders | | Storeroom | Cost of materials; number of requisitions filled; number of units handled. | | Factory office | Number of employees; labor hours; labor costs | | Personnel | Number of employees; labor hours; labor cost | | Building maintenance | Floor space occupied | | Power plant | Kilowatt hours of power usage | ## Methods of Allocating Service Cost to Producing Department 1. **Direct Method** 2. **Step Method** 3. **Reciprocal / Algebraic Method** ### **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 department. ### **Step Method** - Recognizes services rendered by other service departments. - **Sequential basis of allocation:** - Allocation starts with the department that renders the service to the greatest number of departments. - If two or more service departments renders to the same number of departments, select the department with the highest cost. - Once a service department has allocated its cost, no other service cost may be allocated to it. ### **Reciprocal / Algebraic Method** - Allocates cost by including the mutual services rendered among all departments. - Uses algebraic equations to give a more precise allocation to producing departments. ## Illustration To illustrate the allocation procedures of service departments' costs to producing departments, assume the following data for April 2024: | Service Department | Allocation Bases | |---|---| | Personnel | Number of employees in each producing department | | Building Maintenance | Floor space occupied by each producing department | | Power Plant | Kilowatt hours of power usage in each producing department | The following data for each department during April 2024 are obtained: | Department | Costs | No. of Employees | Floor Space | Kilowatt Hours | |---|---|---|---|---| | **Service Department** | | | | | | Personnel | P 3,600 | 5 | 1,500 | - | | Building Maintenance | 2,000 | 4 | 2,500 | - | | Power Plant | 1,000 | 2 | 4,000 | - | | **Producing Department** | | | | | | Machining | 11,800 | 10 | 10,000 | 7,000 | | Assembly | 8,600 | 20 | 10,000 | 3,000 | The bases to be used under direct allocation of service departments' costs to Machining and Assembly departments are presented as follows: | | Machining | Assembly | Total | |---|---|---|---| | Personnel (Number of employees) | 10 | 20 | 30 | | Building Maintenance (Sq. ft. of floor space) | 10,000 | 10,000 | 20,000 | | Power Plant (Kilowatt hours of power used) | 7,000| 3,000 | 10,000 | ### **Solution: Direct Method** The direct allocation of service department overhead costs for the month of April 2024 is as follows: | Department | Costs | Proportion Machining | Proportion Assembly | |---|---|---|---| | Personnel | P3,600 | 10/30 P1,200 | 20/30 P2,400 | | Building Maintenance | 2,000 | 10,000 / 20,000 1,000 | 10,000 / 20,000 1,000 | | Power Plant | 1,000 | 7,000 / 10,000 700 | 3,000 / 10,000 300 | ### **Solution: Step Method** The allocation using the step method is presented as follows: | Department | Cost | Personnel | Building Maintenance | Power Plant | Machining | Assembly | |---|---|---|---|---|---|---| | Personnel | P3,600 | (P3,600) | P 400 (4/36) | P 200 (2/36) | P 1,000 (10/36) | P 2,000 (20/36) | | Building Maintenance | 2,000 | (2,400) (2,000+400) | 400 (4/24)| 1,000 (10/24) | 1,000 (10/24)| | Power Plant | 1,000 | (1,600) (1,000+600) | 1,120 (7/10) | 480 (3/10) | ### **Reciprocal Method** To illustrate, assume the following data for Departments A, B, and C which provides services to each other and to producing departments X and Y. | Total Cost | A | B | C | X | Y | |---|---|---|---|---|---| | A - P 200,000 | - | 15% | 5% | 55% | 25%| | B - 140,000 | 10% | - | 9% | 18% | 63%| | C - 100,000 | - | - | - | 20% | 80% | The following equations may be developed: - A(costs) = P200,000 + 0.10B - B(costs) = P140,000 + 0.15A - C(costs) = P100,000 + .05A + .09B The simultaneous equations may be solved algebraically as follows: 1. Substituting the equation for A into the B equation gives the value of B as follows: - B = P140,000 + .15 (P200,000 + .10B) - B= P140,000 + 30,000 + .015B - .985B = P170,000 - B = P172,589 2. Substituting the value of B into the A equation gives the value of A as follows: - A = P200,000 + .10 (P172,589) - A = P217,259 3. The C equation can be solved by substituting the calculated values of A and B as follows: - C = P100,000 + .05 (P217,259) + .09 (P172,589) - C= P100,000 + P10,863 + P15,533 - C = P126,396 The allocation of costs of Service Departments A, B, and C according to percentage of services can be made as follows: | | A | B | C | X | Y | |---|---|---|---|---|---| | Cost prior to allocation | P 200,000 | P140,000 | P100,000 | - | - | | Allocation of A | (217,259) | 32,589 | 10,863 | 119,492 | 54,315 | | Allocation of B | 17,259 | (172,589) | 15,533 | 31,066 | 108,731 | | Allocation of C | - | - | (126,396) | 25,279 | 101,117 | | Total | P0 | P0| P0 | P175,837 | P264,163 | ## Comprehensive Illustration: Step Method Manufacturing is completed in two producing departments - Department A and Department B The two producing departments are serviced by two service departments - Factory Office and Storeroom. Factory survey show the following bases of distributing costs of service departments: - Factory Office - Number of employees - Storeroom - Number of units of materials requisitioned The basis of computing predetermined overhead rates of Producing Departments is: - Department A - Estimated machine hours - Department B - Estimated direct labor hours The data used in determining allocations and rates are: | Departments | Machine Hours | Direct Labor Hours | Area in Square Feet | No. of Employees | Units of Materials Requisitioned | |---|---|---|---|---|---| | Department A | 20,000 | 30,000 | 20,000 | 12 | 3,000 | | Department B | 10,000 | 20,000 | 16,000 | 8 | 2,000 | | Factory Office | - | - | 4,000 | - | - | | Storeroom | - | - | 10,000 | 4 | - | | Total | 30,000 | 50,000 | 50,000 | 24 | 5,000 | The budgeted manufacturing costs at the beginning of the year are as follows: | | | |---|---| | Factory Office | P 51,600 | | Storeroom | 16,400 | | Department A | 28,300 | | Department B | 19,800 | | Total | P 116,100 The allocation of service departments' costs using the step method is presented as follows: | Department | Factory Office | Storeroom | Department A | Department B | Total | |---|---|---|---|---|---| | Total costs prior to Allocation | P 51,600 | P 16,400 | P 28,300 | P 19,800 | P 116,100 | | Allocation of Factory Office | (51,600) | 8,600 | 25,800 | 17,200 | - | | Allocation of Storeroom | (25,000) | - | 15,000 | 10,000 | - | | Totals | P 0 | P 0 | P 69,100 | P 47,000 | P 116,100 | A. Allocation of Factory Office costs based on number of employees: - Storeroom: 4/24 x P51,600 = P 8,600 - Department A: 12/24 x P 51,600 = 25,800 - Department B: 8/24 x P 51,600 = 17,200 B. Allocation of Storeroom costs based on units of materials requisitioned: - Department A: 3,000 / 5,000 x P25,000 = P 15,000 - Department B: 2,000 / 5,000 x P 25,000 = 10,000 The predetermined overhead application rates for the Producing Department are computed as follows: - Department A: P 69,100 / 20,000 machine hours = P 3.455 per machine hour - Department B: P 47,000 / 20,000 direct labor hours = P 2.35 per direct labor hour ## Recording Applied Departmental Manufacturing Overhead Assume that actual machine hours for Department A is 18,000 hours while actual direct labor hours for Department B is 21,000 hours: - Work in Process (18,000 x P 3.455) = P 62,190 - Manufacturing Overhead Control- Dept. A = P 62,190 - Work in Process ( 21,000 x P 2.35) = P 49,350 - Manufacturing Overhead Control - Dept. B = P 49,350 ## Recording Actual Departmental Manufacturing Overhead Assume that the actual manufacturing overhead charged to Department A and Department B are P 45,000 and P 55,850 respectively: - Manufacturing Overhead Control - Dept. A = P 45,000 - Manufacturing Overhead Control - Dept. B = 55,850 - Manufacturing Overhead Control = P 100,850 | | Actual Mfg. Overhead | Applied Mfg. Overhead | Over (Under-Applied) Mfg. Overhead | |---|---|---|---| | Department A | P 45,000 | P 62,190 | P 17.190 | | Department B | 55,850 | 49,350 | (6.500) | - Overapplied Manufacturing Overhead - Dept A = P 17,190 - Cost of Goods Sold = P 17,190 - Cost of Goods Sold = P 6,500 - Underapplied Manufacturing Overhead - Dept B = P 6,500 # Thank You