Need and Bases of Apportionment of Common Expenses

An apportionment is the separation of sales, expenditures, or income that are then distributed to different accounts, divisions, or subsidiaries. The term is used in particular for allocating profits to a company’s specific geographic areas, which affects the taxable income reported to various governments.

When all the items are collected properly under suitable account headings, the next step is allocation and apportionment of such expenses to cost centres. This is also known as departmentalisation of overhead. Departmentalisation of production overheads is the process of identifying production overhead expenses with different production/service departments or cost centres. It is done by means of allocation and apportionment of overheads among various departments.

For example, a multi-state entity’s overall revenue may be distributed to its state-level branches based on their individual revenues, headcount, asset base, or cash receipts.

An apportionment is the separation of sales, expenditures, or income that are then distributed to different accounts, divisions, or subsidiaries. The term is used in particular for allocating profits to a company’s specific geographic areas, which affects the taxable income reported to various governments.

For example, a multi-state entity’s overall revenue may be distributed to its state-level branches based on their individual revenues, headcount, asset base, or cash receipts.

Basis for Apportionment

The basis used for apportionment of costs is the number of cost centres when the expenses are to be shared equitably between them. This happens when an overhead cannot be assigned directly to one specific cost centre.

Rent and business rates, for example, are sometimes paid by individual cost centres, and floor space is also used as a basis for apportionment to share costs between relevant cost centres.

The costs are proportionately assigned to different departments when the overhead belongs to various departments. In simple terms, the expenses which cannot be charged against a specific department are dispersed over multiple departments.

For example, the wages paid to the factory head, factory rent, electricity, etc. cannot be charged to a particular department, then these can be apportioned among several departments.

Following are the main bases of overhead apportionment utilised in manufacturing concerns:

(i) Direct Allocation:

Overheads are directly allocated to various departments on the basis of expenses for each department respectively. Examples are: overtime premium of workers engaged in a particular department, power (when separate meters are available), jobbing repairs etc.

(ii) Direct Labour/Machine Hours:

Under this basis, the overhead expenses are distributed to various departments in the ratio of total number of labour or machine hours worked in each department. Majority of general overhead items are apportioned on this basis.

(iii) Value of Materials Passing through Cost Centres:

This basis is adopted for expenses associated with material such as material handling expenses.

(iv) Direct Wages:

According to this basis, expenses are distributed amongst the departments in the ratio of direct wages bills of the various departments. This method is used only for those items of expenses which are booked with the amounts of wages, e.g., workers’ insurance, their contribution to provident fund, workers’ compensation etc.

(v) Number of Workers:

The total number of workers working in each department is taken as a basis for apportioning overhead expenses amongst departments. Where the expenditure depends more on the number of employees than on wages bill or number of labour hours, this method is used. This method is used for the apportionment of certain expenses as welfare and recreation expenses, medical expenses, time keeping, supervision etc.

(vi) Floor Area of Departments:

This basis is adopted for the apportionment of certain expenses like lighting and heating, rent, rates, taxes, maintenance on building, air conditioning, fire precaution services etc.

(vii) Capital Values:

In this method, the capital values of certain assets like machinery and building are used as basis for the apportionment of certain expenses.

Examples are:

Rates, taxes, depreciation, maintenance, insurance charges of the building etc.

(viii) Light Points:

This is used for apportioning lighting expenses.

(ix) Kilowatt Hours:

This basis is used for the apportionment of power expenses.

(x) Technical Estimates:

This basis of apportionment is used for the apportionment of those expenses for which it is difficult, to find out any other basis of apportionment. An assessment of the equitable proportion is carried out by technical experts. This is used for distributing lighting, electric power, works manager’s salary, internal transport, steam, water charges etc. when these are used for processes.

Principles of Apportionment of Overhead Costs:

The determination of a suitable basis is of primary importance and the following principles are useful guides to a cost accountant:

(i) Service or Use or Benefit Derived:

If the service rendered by a particular item of expense to different departments can be measured, overhead can be conveniently apportioned on this basis. Thus, the cost of maintenance may be apportioned to different departments on the basis of machine hours or capital value of the machines, rent charges to be distributed according to the floor space occupied by each department.

(ii) Ability to Pay Method:

Under this method, overhead should be distributed in proportion to the sales ability, income or profitability of the departments, territories, basis of products etc. Thus, jobs or products making higher profits take a higher share of the overhead expenses. This method is inequitable and is not generally advisable to relieve inefficient units at the cost of efficient units.

(iii) Efficiency Method:

Under this method, the apportionment of expenses is made on the basis of production targets. If the target is exceeded, the unit cost reduces indicating a more than average efficiency. If the target is not achieved, the unit cost goes up, disclosing thereby the inefficiency of the department.

(iv) Survey Method:

In certain cases it may not be possible to measure exactly the extent of benefit wick the various departments receive as this may vary from period to period, a survey is made of the various factors involved and the share of overhead costs to be borne by each cost centre is determined.

Thus, the salaries of foreman serving two departments can be apportioned after a proper survey which may reveal that 30% of such salary should be apportioned to one department and 70% to the other department. The cost of lighting, when not metered, may similarly be apportioned on a survey of the number and wattage of light points and the hours of use in each cost centre.

Principles of apportionment of overhead expenses

The guidelines or principles which facilitate in determining a suitable basis for apportionment of overheads are explained below:

1. Derived Benefit

According to this principle, the apportionment of common items of overheads should be based on the actual benefit received by the respective cost centers. This method is applicable when the actual benefits are measurable. e.g., rent can be apportioned on the basis of the floor area occupied by each department.

2. Potential Benefit

According to this principle, the apportionment of the common item of overheads should be based on potential benefits (i.e., benefits likely to be received). When the measurement of actual benefit is difficult or impossible or uneconomical this method is adopted. e.g., the cost of canteen can be apportioned on the basis of the number of employees in each department which is a potential benefit.

3. Ability to Pay

According to this principle, overheads should be apportioned on the basis of the saleability or income generating ability of respective departments. In other words, the departments which contribute more towards profit should get a higher proportion of overheads.

4. Efficiency Method

According to this principle, the apportionment of overheads is made on the basis of the production targets. If the target is higher, the unit cost reduces indicating higher efficiency. If the target is not achieved the unit cost goes up indicating inefficiency of the department.

5. Specific Criteria Method:

According to this principle, apportionment of overhead expenses is made on the basis of specific criteria determined in a survey. Hence this method is also known as “Survey method”. When it is difficult to select a suitable basis in other methods, this method is adopted. e.g., while apportioning salary of the foreman, a careful survey is made to know how much time and attention is given by him to different departments. On the basis of the above survey, the apportionment is made.