by Distribution refers to the process of allocating, apportioning, and absorbing costs across different departments, cost centers, or products. In cost accounting, distribution ensures that overhead expenses such as rent, electricity, and maintenance are fairly assigned to production and service departments. It involves Primary distribution (initial allocation to departments) and Secondary distribution (reallocation of service department costs to production units). Proper distribution enhances accurate product costing, pricing decisions, and financial control. It helps businesses in budgeting, cost management, and profitability analysis by ensuring that all indirect costs are systematically accounted for and absorbed into the final product cost.
Primary Distribution:
Primary distribution is the initial allocation of overhead costs to various departments or cost centers based on relevant bases. It involves distributing indirect expenses such as rent, depreciation, salaries, and utilities to both production and service departments. The allocation is done using appropriate criteria, like floor area for rent or machine hours for power consumption. This step ensures that each department bears a fair share of common expenses before further cost apportionment. Accurate primary distribution is essential for cost control, pricing decisions, and profitability analysis, as it forms the foundation for effective cost allocation and absorption processes.
Types of Primary Distribution:
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Overhead Distribution Based on Floor Area
Overheads such as rent, lighting, and heating are distributed based on the floor space occupied by each department. This method ensures that departments using larger areas bear a proportionate share of costs. It is simple to apply but may not always reflect actual resource usage.
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Overhead Distribution Based on Direct Labor Hours
This method allocates overheads based on the number of labor hours worked in each department. It is effective for labor-intensive industries where labor is a key factor in production, ensuring fair cost allocation.
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Overhead Distribution Based on Machine Hours
Here, costs are distributed based on machine usage in each department. It is suitable for capital-intensive industries where machines contribute significantly to production. This method provides a more accurate cost allocation, reflecting the true overhead burden.
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Overhead Distribution Based on Direct Wages
In this method, overheads are apportioned based on the wages paid to employees in each department. It assumes that higher wages indicate higher productivity, making it relevant for labor-dominated industries but less accurate for machine-intensive setups.
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Overhead Distribution Based on Units Produced
Overheads are distributed in proportion to the number of units produced by each department. This method is simple but may not accurately reflect costs when departments have different levels of automation or varying production complexity.
Secondary Distribution:
Secondary distribution is the process of reallocating service department overheads to production departments after the primary distribution. Since service departments (e.g., maintenance, canteen) do not directly produce goods, their costs are transferred to production departments using logical bases, such as labor hours or machine usage. This ensures that all overhead costs are fully absorbed into production. Methods like direct redistribution, step-down method, and reciprocal method are commonly used for secondary distribution. Accurate secondary distribution helps in determining the true cost of production, aiding in pricing, budgeting, and cost control for better financial decision-making.
Types of Secondary Distribution:
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Direct Redistribution Method
In this method, service department costs are directly assigned to production departments based on predefined allocation bases like labor hours or machine usage. It is simple and easy to apply but does not consider the inter-service department cost sharing, making it less accurate in complex setups.
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Step-Down Method (Sequential Method)
Here, service department costs are allocated to other service departments first and then to production departments in a sequential order. The most service-intensive department is allocated first, ensuring a more logical distribution of costs but ignoring full reciprocity between service departments.
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Reciprocal Method (Simultaneous Equation Method)
This method fully recognizes the mutual services exchanged between service departments before allocating costs to production departments. It provides the most accurate distribution but requires complex mathematical techniques like simultaneous equations or iterative methods for calculation.
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Repeated Distribution Method
This technique repeatedly distributes service department costs to other service and production departments in multiple rounds until all costs are absorbed. It is more accurate than the step-down method but can be time-consuming.
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Dual Allocation Method
Under this method, service department costs are divided into fixed and variable components. The fixed portion is allocated on a predetermined basis, while the variable portion is assigned based on actual usage. This ensures a fairer cost distribution, especially in dynamic production environments.
