Primary and Secondary Overheads Distribution using Reciprocal Service Methods (Repeated Distribution Method and Simultaneous Equation Method)

In cost accounting, overheads are indirect costs that cannot be directly traced to a specific product, job, or process. These costs are incurred for the overall functioning of the organisation and include expenses such as factory rent, power, lighting, supervision, depreciation, repairs, and maintenance.

Since overheads cannot be charged directly to products, they must be systematically collected, classified, allocated, apportioned, and absorbed to determine the true cost of production. Overhead distribution is a critical part of this process.

Meaning of Overhead Distribution

Overhead distribution refers to the process of assigning indirect costs to various departments and finally to products. It ensures that each department bears a fair share of overhead expenses.

Overhead distribution is carried out in three distinct stages:

• Primary Distribution

• Secondary Distribution

• Final Absorption

Classification of Departments

For overhead distribution, departments are classified into:

1. Production Departments

These departments are directly engaged in manufacturing goods.
Examples:

• Machining Department

• Assembly Department

• Finishing Department

2. Service Departments

These departments provide services to production departments and sometimes to other service departments.
Examples:

• Maintenance Department

• Power House

• Stores Department

• Personnel Department

Primary Distribution of Overheads

Primary distribution refers to the allocation and apportionment of overheads to both production and service departments.

At this stage, overheads are collected department-wise but not yet charged to products.

Objectives of Primary Distribution

• To classify overheads department-wise

• To allocate directly identifiable overheads

• To apportion common overheads fairly

• To prepare for secondary distribution

Methods Used in Primary Distribution

(a) Allocation

Allocation is used when overheads can be directly identified with a specific department.
Examples:

• Salary of department supervisor

• Repairs of a specific machine

(b) Apportionment

Apportionment is used when overheads are common to several departments and must be divided on an equitable basis.
Examples:

• Rent → Floor area

• Power → Machine hours

• Canteen expenses → Number of employees

Result of Primary Distribution

After primary distribution:

• Overheads are shown separately for each production department

• Overheads are also shown for each service department

These service department overheads must now be redistributed to production departments through secondary distribution.

Secondary Distribution of Overheads

Secondary distribution refers to the re-apportionment of service department overheads to production departments.

Since service departments do not produce goods, their costs must ultimately be borne by production departments.

Need for Secondary Distribution

• To determine accurate production cost

• To avoid under- or over-absorption of overheads

• To ensure fair distribution of indirect costs

Reciprocal Services

Reciprocal services exist when two or more service departments render services to each other, in addition to serving production departments.

Example:

• Maintenance department repairs Power House equipment

• Power House supplies electricity to Maintenance department

Such mutual services make overhead distribution complex.

Problem with Simple Distribution

Simple methods like direct distribution ignore services rendered among service departments. This leads to inaccurate cost allocation.

Hence, Reciprocal Service Methods are used.

Reciprocal Service Methods

The two most important reciprocal service methods are:

• Repeated Distribution Method

• Simultaneous Equation Method

REPEATED DISTRIBUTION METHOD

Repeated Distribution Method, also known as the Trial and Error Method, distributes service department overheads repeatedly among production and other service departments until the service department balances become negligible.

Assumption

• Service departments provide services to each other continuously

• Distribution continues until service department overheads are fully absorbed by production departments

Procedure

• Select a service department and distribute its overheads to all departments based on given ratios

• Take the next service department and distribute its revised overheads

• Repeat the process again and again

• Stop when the remaining service department balances are insignificant

Illustration (Conceptual)

Service Department A provides services to:

• Production Dept X

• Production Dept Y

• Service Dept B

Service Dept B also provides services to:

• Production Dept X

• Production Dept Y

• Service Dept A

Distribution continues until:

• Service Dept A = Nil

• Service Dept B = Nil

Merits of Repeated Distribution Method

• Easy to understand

• Suitable for manual calculations

• Logical approach to mutual services

• Commonly used in examinations

Demerits of Repeated Distribution Method

• Time-consuming

• Tedious for large data

• Results may not be perfectly accurate

• Requires multiple rounds of calculation

Suitability

This method is suitable when:

• Reciprocal services are complex

• Mathematical expertise is limited

• Approximate accuracy is acceptable

SIMULTANEOUS EQUATION METHOD

Simultaneous Equation Method, also known as the Algebraic Method, distributes service department overheads by forming and solving algebraic equations that reflect mutual services.

Under this method:

• Total cost of each service department is treated as a variable

• Mutual services are expressed mathematically

• Equations are solved simultaneously to obtain true service department costs

Assumptions

• Reciprocal services are accurately measurable

• Mathematical solution is feasible

• Final service department costs reflect all mutual services

Procedure

• Assume total cost of service departments as variables (e.g., X and Y)

• Form equations showing how much service each department receives

• Solve equations simultaneously

• Distribute final costs to production departments only

Illustration (Conceptual)

Let:

• X = Total cost of Service Dept A

• Y = Total cost of Service Dept B

If:

• A receives 20% service from B

• B receives 10% service from A

Then:

• X = Original cost of A + 20% of Y

• Y = Original cost of B + 10% of X

Solving these gives true costs of A and B.

Merits of Simultaneous Equation Method

• Most accurate method

• Scientifically sound

• Avoids approximation

• Suitable for large organisations

Demerits of Simultaneous Equation Method

• Complex and difficult to understand

• Requires algebraic knowledge

• Not suitable for beginners

• Time-consuming if many service departments exist

Suitability

This method is suitable when:

• High accuracy is required

• Reciprocal services are significant

• Cost data is used for pricing and strategic decisions

Comparison of the Two Methods

Importance of Reciprocal Service Methods

• Ensures accurate cost allocation

• Reflects true cost of production

• Prevents distortion in product costing

• Supports pricing, budgeting, and profitability analysis

• Improves managerial decision-making