Secondary Overhead Distribution, Concepts, Objectives, Types, Importance and Role of Primary Distribution in Cost Control

Secondary overhead distribution is the second stage of overhead distribution in cost accounting. At this stage, the overheads of service departments are redistributed to production departments, since service departments do not directly participate in production. This redistribution ensures that total production overheads are accurately absorbed into product costs.

Meaning of Secondary Overhead Distribution

Secondary overhead distribution refers to the process of re-apportioning service department overheads to production departments based on the extent of services rendered. It begins after primary distribution and ensures that production departments bear a fair share of indirect costs incurred by service departments.

Objectives of Secondary Overhead Distribution

Secondary overhead distribution aims at transferring service department costs to production departments so that accurate product costing can be achieved. The objectives can be explained under the following eight points, each explained in detail.

• Transfer of Service Department Costs

The primary objective of secondary overhead distribution is to transfer the overheads of service departments to production departments. Since service departments do not directly produce goods, their costs must be reassigned to production departments to ensure complete and accurate costing of production activities.

• Accurate Product Costing

Secondary distribution ensures that product costs include both direct costs and a fair share of indirect service department costs. Without this redistribution, product costs would be understated, leading to incorrect pricing, profit measurement, and misleading cost information.

• Elimination of Service Department Costs

By redistributing service department overheads to production departments, secondary distribution eliminates service department balances from final cost records. This ensures that only production department costs remain for absorption into products, simplifying final costing.

• Fair Distribution of Overheads

Secondary distribution ensures that service department costs are shared among production departments based on the actual benefits received. This avoids arbitrary charging and promotes fairness and accuracy in overhead distribution.

• Basis for Overhead Absorption

Secondary distribution provides a correct overhead base for absorption into cost units. Once service department costs are transferred, total production overheads can be absorbed into products using suitable absorption rates.

• Improved Cost Control

By redistributing service department costs, management can analyze the efficiency of production departments more accurately. It helps identify excessive service usage and encourages better utilization of support services, improving overall cost control.

• Supports Managerial Decision-Making

Accurate allocation of service department costs assists management in decisions related to pricing, budgeting, outsourcing, capacity utilization, and performance evaluation. Reliable cost data enhances the quality of managerial decisions.

• Ensures Realistic Profit Measurement

Secondary overhead distribution ensures that all indirect costs are included in production costs, leading to realistic profit determination. It prevents overstatement or understatement of profits and provides a true picture of business performance.

Types of Secondary Overhead Distribution

Secondary overhead distribution deals with the redistribution of service department overheads to production departments. Depending on how inter-service department services are treated, secondary overhead distribution is classified into the following types (methods):

1. Direct Distribution Method

Under this method, the overheads of service departments are directly distributed to production departments only, ignoring services rendered among service departments. The distribution is done based on suitable bases such as labour hours or machine hours. This method is simple but less accurate.

2. Step Ladder Method (Sequential Distribution Method)

In this method, service department costs are distributed step by step to other departments, including other service departments, in a predetermined order. Once a service department’s cost is distributed, it is not redistributed again. This method partially recognizes inter-service department services.

3. Repeated Distribution Method

This method repeatedly distributes service department costs to other departments, including service departments, based on the proportion of services rendered. The process continues until the service department balances become negligible. It gives more accurate results than the step ladder method.

4. Reciprocal Service Method

The reciprocal service method fully recognizes mutual services between service departments. It is applied when service departments provide services to each other, ensuring accurate redistribution of costs.

5. Simultaneous Equation Method

This is the most accurate method of secondary overhead distribution. Algebraic equations are framed for each service department, considering mutual services. After solving the equations, total service department costs are distributed to production departments.

Importance of Secondary Overhead Distribution

Secondary overhead distribution is an essential stage in accounting for overheads, as it ensures that service department costs are properly transferred to production departments. Its importance can be explained under the following eight points, each clearly explained.

• Accurate Product Costing

Secondary overhead distribution ensures that all service department costs are included in product costs. By transferring these indirect costs to production departments, products reflect their true cost of production, leading to reliable costing information.

• Fair Allocation of Overheads

It distributes service department overheads among production departments based on actual services received. This ensures fairness and avoids arbitrary allocation of indirect costs, improving cost accuracy.

• Basis for Overhead Absorption

Secondary distribution provides a correct total of production department overheads. These totals are then absorbed into products using suitable absorption rates, ensuring accurate recovery of overheads.

• Elimination of Service Department Balances

By redistributing service department overheads, secondary distribution eliminates service department balances from cost records. This simplifies final costing and focuses attention on production departments only.

• Improves Cost Control

Secondary distribution helps management monitor service department costs and their usage by production departments. Excessive or inefficient use of services can be identified and controlled.

• Supports Managerial Decision-Making

Accurate redistribution of overheads supports managerial decisions related to pricing, budgeting, outsourcing, and capacity utilization. Reliable cost data enhances planning and strategic decisions.

• Facilitates Performance Evaluation

By allocating service costs to production departments, management can evaluate departmental efficiency more accurately. It helps compare performance across departments and periods.=

• Ensures Realistic Profit Measurement

Secondary overhead distribution ensures inclusion of all indirect costs in production, preventing overstatement or understatement of profits and presenting a true picture of business performance.

Role of Secondary Overhead Distribution in Cost Control

Secondary overhead distribution plays a significant role in controlling indirect costs by ensuring proper redistribution of service department overheads to production departments. Its role in cost control can be explained under the following eight points, each explained clearly.

• Identification of Service Cost Usage

Secondary distribution helps identify how much service department cost is utilized by each production department. This visibility enables management to monitor service usage and control excessive or unnecessary consumption of support services.

• Accurate Departmental Cost Control

By transferring service department costs to production departments, management can control total departmental overheads more effectively. It ensures that production departments are accountable for the services they consume.

• Comparison with Standards and Budgets

Secondary distribution allows comparison of redistributed overheads with budgeted or standard costs. Variances highlight inefficiencies or wastage, enabling timely corrective actions.

• Responsibility Fixation

Allocating service costs to production departments fixes responsibility for overhead control. Department managers become conscious of service usage and strive to minimize avoidable costs.

• Elimination of Hidden Costs

Without secondary distribution, service department costs remain hidden and uncontrolled. Redistribution brings these costs into production overheads, making them visible and controllable.

• Encourages Efficient Use of Services

When production departments bear service costs, they become more careful in using services like maintenance, power, and stores. This encourages efficiency and cost-conscious behavior.

• Supports Cost Reduction Programs

Secondary distribution highlights high-cost service areas and excessive usage patterns. This information helps management implement cost reduction measures and process improvements.

• Improves Overall Cost Efficiency

By ensuring fair and systematic redistribution of service overheads, secondary distribution strengthens overall cost control, reduces wastage, and enhances operational efficiency across the organization.