In this article we will discuss about the re-apportionment of service centre costs. Also learn about the methods generally used in allocation of service department costs.
Service departments may exist to provide services of various kinds to other departments. For example, personnel, maintenance, boiler house, pump house, power generation departments are service departments which provide service to the production and other service centres. In some instances the service departments may even consume part of their services themselves.
It is common that in all organizations the overheads will be incurred by both production and service departments. Hence, in the first step, all the overhead costs should be allocated or apportioned to the production and service departments on some equitable basis. This is called ‘primary distribution’ of overheads.
The service departments render service (benefit) to the production departments. In ascertainment of production departments cost the expenses of service departments are to be reapportioned amongst production departments only. This process of redistribution of service departments cost to production departments is called ‘secondary distribution’ of overheads.
It means re-distribution of service cost centres’ overheads to production cost centres on some suitable basis/method because, the overheads are finally recovered through the production cost centres only.
The methods generally used in allocation of service department costs are explained as follows:
(a) Direct Method:
Under this method, the service department’s total costs are directly allocated to production departments. This method used when a direct percentage of use of service departments by production departments is known. This method ignores any services rendered by one service department to another.
(b) Step-Down Method:
This method recognizes the services provided to other service departments using a sequence of reallocations in which service department costs are allocated in turn to production departments and to other service departments. But no further costs are allocated to a service department once its costs have been allocated.
The basic assumption of this method is that when one service department’s costs are apportioned, that particular department is then eliminated from any apportionment of the other service departments.
This method ignores the concept of ‘reciprocal services’. Thus, this method ignores the complexity of situations in which two or more service department’s simultaneously provide services to each other, as well as to production departments. This method is also called as ‘elimination method’.
Self-help Ltd. has genests and produces its own power. Data for power Costs are as follows:
During the month of May costs for generating power amounted to Rs. 9,300; of this Rs. 2,500 was considered to be fixed cost. Service Department ‘X’ renders service to A, B and Y in the ratio 13:6:1, while Service Department ‘Y’ renders service to A and B in the ratio 31:3. Given that the direct labour hours in departments A and B are 1,650 hours and 2,175 hours respectively, find the power cost per labour hour in each of these two departments.
(c) Repeated Distribution Method:
This method takes into account the reciprocal services of services departments. Under this method the primary distribution of overheads is made to production and service departments on regular basis.
Then, service department costs are repeatedly allocated in the specified percentages. This process continues until all the service costs have been fully transferred into the production departments. This is a laborious method and a computer can be used in the calculations. This method is also known as ‘continuous allotment’ method.
Modern Manufacturers Ltd. Have three production Departments P1, P2 and P3 and two Service Departments S1 and S2, the details pertaining to which are as under:
Find out the total cost of Product X which is processed for manufacture in Departments P1, P2, and P3 for 4, 5 and 3 hours respectively, given that its direct material cost is Rs. 50 and direct labour cost Rs. 30.
(d) Simultaneous Equations Method:
Under this method, mathematical simultaneous equations are formulated and then equations are solved. This method is also called ‘algebraic’ method.
The Space Production Company manufactures components for radio and television satellites using two service departments and two production departments.
The interdepartmental relationships and estimated overhead costs are given below:
Percentage of services provided to:
(i) Using the direct method, show the amount of Scheduling Department costs to be allocated to Assembly Department.
(ii) Repeat (i) using the step method and allocating maintenance first.
(iii) Repeat (i) using the Reciprocal Method (method of Simultaneous equations may be used.)
(i) Direct method – Scheduling department costs to be allocated to Assembly department is 30% of Rs. 4,00,000 = Rs. 1,20,000
(e) Reciprocal Method:
Let ‘M’ be the overheads of Maintenance Department and ‘S’ be the overheads of Scheduling Department
M = 7,50,000 + 0.2 S…………………….. (1)
S = 4,00,000 + 0.1 M……………………. (2)
By substituting equation (2) in equation (1)
M = 7,50,000 + 0.2 (4,00,000 + 0.1 M)]
M = 7,50,000 + 80,000 + 0.02 M
M – 0.02 M = 7,50,000 + 80,000
0.98 M = 8,30,000
M = 8,30,000/0.98
M = Rs. 8,46,939
S = 4,00,000 + (0.1 x 8,46,939)
= 4,00,000 + 84,694
= Rs. 4,84,694