Need and Bases of Apportionment of Common Expenses

Apportioning common expenses is crucial for the accurate allocation of costs that are shared across multiple departments or business units within an organization. Common expenses are incurred for the overall benefit of the organization and cannot be directly traced to a specific department. These expenses must, therefore, be distributed among the departments or business units that benefit from them.

Need for apportioning Common Expenses arises from the following factors:

• Fair Cost Allocation

Without apportionment, departments would not fairly bear the costs of shared resources, leading to misallocation of resources. For instance, if one department occupies more space than another, it should bear a larger portion of shared rent. Apportioning costs ensures fairness and transparency in financial reporting.

• Accurate Departmental Profitability

Departments often need to assess their financial performance to determine profitability. Apportioning common expenses allows each department to reflect a more accurate picture of its costs, revenues, and profitability. For instance, by allocating the central office’s electricity costs, a marketing department can have a clear idea of its contribution to overhead costs.

• Informed Decision-Making

Proper allocation helps managers make informed decisions regarding departmental budgets, cost-saving measures, and resource distribution. When common expenses are apportioned correctly, managers can better identify areas where cost reductions or efficiency improvements can be made.

• Regulatory Compliance

In some industries or jurisdictions, businesses are required to follow specific accounting principles and standards, including the fair apportionment of shared expenses. For example, regulatory bodies or auditors may require that common expenses, such as insurance, be apportioned accurately among departments.

• Cost Control and Efficiency

Apportioning common expenses helps identify how much each department is utilizing shared resources, which in turn enables better control over those costs. For example, if one department is consuming more than its fair share of utilities, management can take corrective action to ensure that the department operates more efficiently.

• External Reporting

For external financial reporting purposes, especially in large or diversified organizations, apportionment ensures that financial statements reflect a true and fair view of costs and expenses. It also helps in comparing the performance of various departments or business segments.

Bases of Apportionment of Common Expenses

Apportionment bases refer to the criteria or methods used to allocate common expenses among the departments or units that benefit from them. Several bases can be used depending on the nature of the expense and the structure of the organization.

• Floor Area/Space Occupied

For common expenses like rent, utilities, and heating/cooling, the apportionment is often done based on the floor area occupied by each department. If one department occupies 40% of the total space, it will bear 40% of the common expenses related to space usage.

Example: If a company’s total rent is $10,000, and the marketing department occupies 20% of the total space, it will be allocated $2,000 of the rent expense.

• Number of Employees

In some cases, common expenses like central administrative salaries, health insurance, or employee benefits can be allocated based on the number of employees in each department. This method assumes that each employee benefits equally from these shared resources.

Example: If a company has 100 employees and 20 employees work in the finance department, 20% of the common expenses related to employee benefits, such as health insurance, will be allocated to the finance department.

• Revenue/Turnover

Common expenses like corporate marketing or promotional costs can be apportioned based on the revenue generated by each department or product line. The rationale here is that the departments generating more revenue are likely to use more shared services, such as advertising or sales support.

Example: If a company has total revenue of $500,000, and the sales department generates $100,000, it would be responsible for 20% of the common advertising costs.

• Direct Costs or Operating Expenses

This base allocates common expenses based on the direct costs or operating expenses of each department. It is often used for allocating expenses related to utilities or maintenance, where higher operating costs correlate with higher use of shared resources.

Example: If the production department has higher direct costs for materials and labor, it may be allocated a larger share of common expenses like maintenance or utility bills.

• Time Utilization

For common expenses related to equipment usage or shared services (e.g., telephone services or IT support), apportionment can be based on the time each department utilizes the service. Departments that use equipment or services more frequently will bear a higher share of the costs.

Example: If the IT department provides support to all departments, the time spent providing service to each department can be tracked, and common IT support costs can be allocated accordingly.

• Machine Hours or Production Units

For departments engaged in manufacturing or production, machine hours or the number of units produced can serve as the base for apportioning costs related to machinery maintenance, repairs, or depreciation. This method ensures that the departments with higher usage of production facilities pay a proportionally larger share of these costs.

Example: If one department utilizes machinery for 60% of the total machine hours, it will bear 60% of the depreciation and maintenance costs of that machinery.

• Headcount or Employee Salaries

In organizations with large numbers of employees, common expenses such as office supplies, HR management, or training costs may be apportioned based on the headcount of each department. Alternatively, the apportionment can be done according to the total salary costs within each department, as this reflects the relative benefit derived from central services.

Example: If the finance department has a total salary cost of $150,000 and the overall salary cost is $1,000,000, the finance department would bear 15% of the shared office supply costs.

• Benefit Derived (Usage)

Some expenses, such as shared computer systems or IT infrastructure, are apportioned based on the actual usage or benefit derived from the service. Departments that use more of the shared resource will bear a higher share of the costs.

Example: If the IT department handles 70% of all system-related requests for troubleshooting and software support, it will be allocated 70% of the overall IT support costs.