Chapter 7 - Manufacturing Overhead – Departmentalization

Need for Departmentalization

According to Pedro P. Guerrero, in large businesses, factory operations are divided into departments.
This is called departmentalization.¹

Departmentalization requires the use of different overhead rates for applying manufacturing overhead.
Various amounts of manufacturing overhead, instead of a single overhead are charged to jobs or
products as they pass through the different departments. A job or product is charged with
manufacturing overhead for work done in a particular department based on the department’s
predetermined overhead rate.¹

Classification of Departments

Departments are classified into two categories: producing departments and service departments. ¹

Producing departments are those departments that are directly engaged in the manufacturing activities
(for example, assembly, finishing, and packaging departments).¹

Service departments are those departments that assist indirectly by rendering services (for example,
purchasing, medical and maintenance departments) to producing departments.¹

Procedures of Departmentalization

The following are the procedures in departmentalizing manufacturing overhead:

1. Calculate departmental predetermined overhead application rates.¹

2. Apply the predetermined overhead rates to production on a department basis.¹

3. Record actual manufacturing overhead costs by departments in the Departmental Overhead

Calculation of Departmental Overhead Application Rates

The steps involved in the calculation of departmental overhead application rates are as follows:

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.¹

¹Pedro P. Guerrero, Cost Accounting – Principles and Procedural Applications, 2018 Edition
 2. Conduct a factory survey to determine the bases to be used in allocating indirect manufacturing
overhead costs and service department costs.¹

3. Set up an application rates worksheet to facilitate cost distribution by departments.¹

4. Enter budgeted costs that can be traced directly to specific departments as direct departmental
costs.¹

5. Allocate budgeted manufacturing overhead costs that cannot be traced to specific departments
according to the base selected.¹

6. Distribute or reallocate budgeted service department’s costs to producing departments.¹

7. Compute departmental predetermined rates by dividing the total budgeted overhead costs
charged to each producing departments by the base selected.¹

Direct Departmental Overhead Costs

Direct departmental overhead costs are those that can be easily traced to specific departments.
Examples are as follows:

a. Repairs and maintenance – traced to maintenance department¹

b. Indirect labor – traced to payroll summaries of a department¹

c. Indirect materials – traced through stores requisition of a department¹

d. Depreciation of equipment – traced to department using the equipment¹

Allocating Indirect Departmental Costs

It is necessary to obtain certain data to be used as basis of allocating indirect departmental costs to
benefiting and producing departments. This is usually done through a survey of factory facilities and
resources. Each department should be charged with its fair share of the costs determined by the
benefits it has received.¹

Below is a list of some of the indirect departmental costs that require allocation and the best possible
bases usually used.
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 telephones

Light Kilowatt hour

Freight-in Materials used

Allocating Service Department Cost

Service department costs, such as costs of the procurement and receiving departments, are reallocated
to the producing departments since these costs cannot be directly identified to the products
manufactured.¹

Just like in the allocation of indirect departmental costs, a reasonable base must be used to charge the
cost of operating a service department to the producing department being served.¹

A list of some of the service departments and the commonly used allocation bases are presented as
follows:¹

Service Departments Allocation Bases

Procurement Number or orders or cost of materials

Receiving Cost of materials; number of units; no, of orders

Storeroom Cost of materials; no. of requisitions filled; no. 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

a. Direct method

b. Step method

c. Reciprocal method

Illustration:

To illustrate the allocation procedures of service departments’ costs to producing departments,

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 producing dept.

The following data for each department during April 200X are obtained:

Department Costs No. of Employees Floor Space Kilowatt Hours

Service Department

Personnel P3,600 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

Under this method, the costs of each service department are allocated only to producing departments.
The bases to be used under direct allocation of service departments’ costs to Machining and Assembly
departments are presented below:

Machining Assembly Total

Personnel (Number of employees) 10 20 30

Building Maintenance (Square feet of floor space) 10,000 10,000 20,000

Power Plant (Kilowatt hours of power used) 7,000 3,000 10,000

The direct allocation of service department overhead costs for the month of April 200X is as follows:

Department Costs Proportion Machining Proportion Assembly

Personnel P3,600 10/30 P1,200 20/30 P2,400

Building Maintenance 2,000 10K/20K 1,000 10K/20K 1,000

Power Plant 1,000 7K/10K 700 3K/10K 300

P6,600 P2,900 P3,700

Step Method

This method allocates service department costs to all service departments as well as producing
departments. The generally accepted procedures of allocation are:

1. Select the service department serving the most other service departments. When more than
one service department services an equal number of service departments, select the
department with the highest costs.¹

2. Allocate the costs of the service department selected in step 1 to the producing departments
and other service departments based on a relative level of the apportionment base.¹

3. Allocate the costs of each remaining service department selected in the same manner as
described in step 1.¹
 4. Costs of service departments are never allocated back to the departments whose costs have
already been allocated.¹

Using the data in the Illustration, the allocation using the step method is presented below:

Allocated Costs

Department Cost Personnel Building Power Plant Machining Assembly

Maintenance

Personnel P3,600 (P3,600) P400 P200 P1,000 P2,000

(4/36) (2/36) (10/36) (20/36)

Building (2,400) 400 1,000 1,000

Maintenance 2,000 (2,000 +400) (4/24) (10/24) (10/24)

Power Plant 1,000 (1,600) 1,120 480

P6,600 (1,000 (7/10) (3/10)

Reciprocal Method

The reciprocal method provides a way to adjust for the reciprocal services provided among the service
departments. Service department costs and service department reciprocal service relationships are
described by an algebraic equation. The equations are solved simultaneously providing a more precise
allocation of costs to producing departments because it considers the mutual services provided among
the service departments.¹

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.

Percentage of Services

Total Cost A B C X Y

A - P200,000 - 15% 5% 55% 25%

B - 140,000 10% - 9% 18% 63%

Based on the above data, the reciprocal method considers only services from A to B and B to A.

If all reciprocal services are recognized, linear algebra may be used to reach a solution. The following
equations may be developed:

A (costs) = P200,000 + .10B

B (costs) = P140,000 + .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 + P30,000 + .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 P200,000 P140,000 P100,000 P - P -

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 P 0 P 0 P 0 P175,837 P 264,163

Comprehensive Illustration – Step Method

Manufacturing is completed in two producing departments – Department A and Department B. The

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 Hrs. Direct Labor Hrs. Area in Sq. Ft. No. of Emp. Units of Mat. Req.

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 P116,100

The allocation of service department’s costs using the step method is presented below:

Department Factory Office Storeroom Department A Department B Total

Total costs prior

To allocation P 51,600 P16,400 P28,300 P19,800 P116,100

Allocation (Sch.1) (51,600) 8,600 25,800 17,200 -

Total P25,000

Allocation (Sch. 2) (25,000) 15,000 10,000 -

Totals P 0 P 0 P69,100 P 47,000 P116,100

Schedule 1: Allocation of Factory Office costs based on number of employees:

Storeroom: 4/24 x P 51,600 = P8,600

Department A: 12/24 x P 51,600 = 25,800

Department B: 8/24 x P 51,600 = 172,00

Schedule 2: Allocation of Storeroom costs based on units of materials requisitioned:

Department A: 3,000/5,000 x P25,000 = P15,000

Department B: 2,000/5,000 x P25,000 = P10,000

The predetermined overhead application rates for the Producing Departments can be computed as
follows:
Department A: P69,100/20,000 machine hours = P3.455 per machine hour

Department B: P47,000/20,000 direct labor hours = P2.35 per direct labor hour

Recording Applied Departmental Manufacturing Overhead

The amounts applied are summarized periodically and recorded in the general journal by the following
entry:

Work in Process 111,540

Applied Manufacturing Overhead – Dept. A (Actual machine hours of 18,000 x P3.455) 62,190

Applied Manufacturing Overhead – Dept. B ( Actual DL hrs. of 21,000 x P2.35) 49,350

Recording Actual Departmental Manufacturing Overhead

Assume that the actual manufacturing overhead charged to Department A and Department B are
P45,000 and P55,850 respectively. The summary journal entry to record the actual manufacturing
overhead is:

Manufacturing Overhead – Dept. A 45,000

Manufacturing Overhead – Dept. B 55,850

Manufacturing Overhead Control 100,850

To record actual manufacturing overhead charged to Dept. A and B.

At the end of the period, a comparison of the actual and applied manufacturing overhead of each
department is made to compute the over or under applied manufacturing overhead as follows:

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)

SOURCE AND REFERENCE:

Pedro P. Guerrero, Cost Accounting – Principles and Procedural Applications, 2018 Edition