Allocation of Overhead to Departments

How do you allocate Overheads to Departments?

Some overheads may be easily identifiable as belonging to particular departments,

• e.g. supervisors specific a particular Department (Dept)

• Depreciation of machines specific to a particular department

For other overheads they might not easily be identifiable for individual departments and may need to be allocated on some basis.

What is step 1 of the Departmental Allocation of Overheads procedure?

Step 1:

• Divide up the overheads into the various production departments of the business using a best estimate.

• Rent costs based on the are occupied by each dept.

• General Machine costs based on number of machines in each dept.

• Light and Heat based on floor space.

• Supervisor costs (where supervise more than one Dept, based on no. of employees in each dept.)

• Add these to the known overheads of each production/service delivery dept.

• There may also be costs of departments which may not be directly involved in production/ service delivery but provide essential backup, for example, maintenance departments, service, etc..

• These costs need to be allocated to production departments on some basis before calculating overhead absorption rates of individual departments.

What is Step 2 of the Departmental Allocation of Overheads?

• Divide up the service department costs into the various production departments of the business using a best estimate.

• For example, the percentage that each department uses the services of the maintenance departments.

• Add these to the known overheads of each production/services delivery department.

What is Step 3 of the Department Allocation of Overheads Procedure?

An activity is chosen upon which the overhead absorption rate is going to be based, for example

• Total machine hours of the department

or

• Total Labour Hours of the department

Choosing the absorption base is quite subjective - try to choose the base that is most appropriate, i.e. what caused the bulk of the overheads?

e.g. choose machine hours if most overheads are generated by machine costs

or

labour hours if most overheads are generated by labour costs.

What is Step 4 of The Departmental Allocation of overheads Procedure?

• The total of O/Hs (overheads) are divided by the activity level (say machine hrs or labour hrs) to produce an ‘overhead absorption rate’.

What is Step 5 of the Departmental Allocation of Overheads Procedure?

• The Overheads are allocated to the job, product or unit of service using the overhead absorption rate.