Basis of Allocation of expenses

22/07/2020 1 By indiafreenotes

Principles for Allocation of Expenses:

The following principles should be noted for the purpose:

(a) Expenses relating to direct benefit of a particular department are charged to the department concerned, e.g., cost of special packing materials is charged to the specific department for which it is used.

(b) Expenses relating to the benefit of more than one department but capable of precise allocation are charged to the departments concerned accordingly, i.e., on some equitable basis, e.g., Rent can be charged to the different departments according to floor area occupied.

(c) Expenses relating to the benefit of more than one department not capable of precise allocation are to be allocated on some arbitrary basis, e.g., Managers salary is to be apportioned on the basis of turnover or cost of sales.

Purpose of Allocation of Expenses:

The following list may be followed for the purpose of allocation of expenses among the different departments:

Expenses:

  1. Selling Expenses, Selling Commissions, Advertisement, Bad Debts, Carriage Outwards, Packing and Delivery Expenses, Godown Rent, Storage, Discount allowed, Travelling Salesmen’s Salary and Commission, After Sale Service, Sales Managers Salary, Provision for Discount Allowed, Freight Outwards etc.
  2. Discount Received, Carriage Inwards Provision for Discount on Creditors.
  3. Rent, Rates, Taxes, Repairs to Building, Insurance, Maintenance or Depreciation of Building, Air Conditioning Expenses, etc.
  4. Lighting, Electricity Charges. Heating etc. Insurance, Depreciation on Plant and Machinery, Fire.
  5. Insurance, Preliminary repairs to assets, Repairs and renewals etc.
  6. Group Insurance Premium, Supervisors’ Salary, Workmen Compensation Insurance, Contribution to ESI etc.
  7. Canteen Expenses, Medical benefits, Labour and Welfare expenses or expenses relating to labour.
  8. Works Manager’s Salary.
  9. Power.
  10. Insurance of Stock.

Basis of Allocation:

  1. Turnover or Sales of each department.
  2. Purchase of each department.
  3. Floor area occupied or Value of floor space
  4. Light Points/Floor Area Occupied Assets value of each department
  5. Direct wages of each department
  6. Numbers of workers
  7. Time spent in each department
  8. Horse Power or Horse Power x Hours worked
  9. Average stock of each department

Note:

There are certain expenses which cannot be apportioned or allocated among the different departments on a suitable basis, the same should be transferred to General Profit and Loss Account (e.g., Interest on Capital, Debenture Interest, Loss on sale of assets, Interest on loan, General Manager’s Salary etc.).

Types of Costs

There are several types of costs that an organization must define before allocating costs to their specific cost objects. These costs include:

  1. Direct costs

Direct costs are costs that can be attributed to a specific product or service, and they do not need to be allocated to the specific cost object. It is because the organization knows what expenses go to the specific departments that generate profits and the costs incurred in producing specific products or services. For example, the salaries paid to factory workers assigned to a specific division is known and does not need to be allocated again to that division.

  1. Indirect costs

Indirect costs are costs that are not directly related to a specific cost object like a function, product, or department. They are costs that are needed for the sake of the company’s operations and health. Some common examples of indirect costs include security costs, administration costs, etc. The costs are first identified, pooled, and then allocated to specific cost objects within the organization.

Indirect costs can be divided into fixed and variable costs. Fixed costs are costs that are fixed for a specific product or department. An example of a fixed cost is the remuneration of a project supervisor assigned to a specific division. The other category of indirect cost is variable costs, which vary with the level of output. Indirect costs increase or decrease with changes in the level of output.

  1. Overhead costs

Overhead costs are indirect costs that are not part of manufacturing costs. They are not related to the labor or material costs that are incurred in the production of goods or services. They support the production or selling processes of the goods or services. Overhead costs are charged to the expense account, and they must be continually paid regardless of whether the company is selling any good or not.