FACTORY OVERHEAD: DEPARTMENTALIZATION

Intended Learning Outcomes

At the end of the lesson, the learner will be able to:

1. Describe the concept of departmentalization
2. Distinguish between service and producing departments
3. Define direct and indirect departmental costs and give examples of each.
4. Compute and use departmental overhead rates
5. Accumulate actual departmental overhead costs.
6. Describe the departmentalization in nonmanufacturing and non-for profit organizations.

The computation of departmental overhead rates requires a series of departmental allocations. These
allocations are necessary for computing predetermined overhead rates prior to the beginning of the
year and again at the end of the period in determining actual departmental overhead.

Departmentalization

Departmentalization of factory overhead means dividing the plant into segments, called departments, to
which overhead costs are charged. For accounting purposes, dividing a plant into separate departments
provides improved product costing and promotes responsible control of overhead costs.

Departmentalization facilitates responsibility accounting and control of overhead costs by making costs
a responsibility of each department’s manager. Costs that originate within a department are identified
with the individual responsible for that department.

The process of departmentalizing overhead is an extension of methods previously discussed. Estimating

or budgeting costs and selecting a proper base for applying them is still necessary. Departmentalizing
overhead requires separate estimates or budgets for each department. Actual costs of a period still are
recorded in a factory overhead control account

Producing and Service Departments

Departments are classified as either producing or service departments. A producing department

manufactures the product by changing the form of material or by assembling parts. A service
department renders a service that contributes in an indirect way to the manufacture of the product and
does not change the form, assembly, or nature of the material. Examples of Producing and service
departments follow:

Producing
Cutting Mixing Brewing
Planing Plating Distilling
Assembly Knitting Glazing
Upholstery Milling Fabricating
Finishing Refining Molding
Machining Bottling Packaging
Cooking Canning Drying
 Service

Utilities Shipping Receiving

Inspection Storage Medical
Production Control Personnel Seccurity
Maintenace Purchasing Cafeteria
Materials Handling Accounting General Factory Cost Pool

DIRECT DEPARTMENTAL COSTS

Factory Overhead consists of all production costs not traceable to specific jobs or products. But in
attributing costs to departments, it is important to keep in mind that departments tend to be relatively
large areas within a company. As a result, many factory overhead costs are traceable to a specific
department. These costs are called direct departmental costs. The majority of direct department
overhead costs can be divided into the following categories: (1) supervision, indirect labor and
overtime, (2) labor fringe benefits, (3) indirect materials and supplies, (4) repairs and maintenance, and
(5) equipment depreciation and rent. These categories generally are readily identified with the
originating department, whether it is a producing or service department.

INDIRECT DEPARTMENTAL COSTS

Costs such as power, light, rent, and depreciation of plant buildings, when shared by all departments are
not charged directly to a department. These costs do not originate with any specific department . They
are incurred for the benefit of all departments, so their cost is allocated among all departments.

Selecting appropriate bases for the allocation of most indirect departmental costs is difficult and
arbitrary. At best, allocations will be reasonable. To charge every department with its share of a cost, a
base common to all departments must be found. For example, square footage can be used for prorating
such expenses as building rent. In plants with departments occupying areas where ceilings are of
varying heights, cubic measurement rather than square footage can be used. Areas occupied by
stairways, elevators, escalators, corridors and aisles must also be considered.

Establishing Departmental Overhead Rates

Factory Overhead usually is applied on the basis of machine hours, direct labor hours, or direct labor
cost when only one overhead rate is used for an entire plant. However, the use of departmental rates
requires a distinct consideration of each producing department’s overhead, which often results in
different bases for different departments , such as a direct labor hour rate for one department and a
machine hour rate for another. A further refinement can lead to multiple bases and rates within a single
producing department.

All factory overhead whether from producing departments or service departments is ultimately
allocated to producing departments . The establishment of departmental overhead rates involves the
following steps:
1. Estimate total departmental overhead of producing and service departments at the expected
activity levels; determine if possible, the fixed and variable nature of each cost category.
2. Prepare a survey (with measurements of al allocation bases) for the purpose of distributing
indirect departmental overhead and service department costs.
 3. Estimate total indirect departmental overhead (such as electric power, fuel, water ,building
depreciation, property tax, and fire insurance) at the selected activity levels and allocate these
costs among departments.
4. Distribute service department costs to benefiting departments.
5. Calculate departmental overhead rates.

Calculating Departmental Overhead Rates

After service department costs have been distributed, producing department overhead rates can be
calculated by dividing each producing departments’ final total factory overhead by a selected allocation
base.

Actual Factory Overhead – Departmentalized

Actual factory overhead is summarized in the factory overhead control account in the general ledger.
Details are entered into the factory overhead subsidiary ledger. Departmentalization of overhead
requires that each cost be charged to a department as well as to a specific subsidiary cost accoinunt.
These charges are collected on departmental cost analysis sheets, which serve as the overhead
subsidiary ledger.

At the end of the year, actual factory overhead costs are assembled in the same manner as estimated
costs at the beginning of the period. When actual indirect departmental overhead is allocated among
the departments, then it is possible to compare actual and applied factory overhead and calculate the
over- or underapplied factory overhead for each producing department.

Multiple Overhead Rates

In a given company there may bee a significant amount of labor-related overhead, machine-related
overhead, materials-related overhead or some combination of these. Some components of factory
overhead cost may not be closely related to the usage of labor, machinery, materials, or any other
measure of production volume. They may be related to activities or transactions such as the number of
setups, or the number of product design changes, neither of which is a measure of production volume.
Costing system that include one or more non-volume related factors among the bases used for
allocating overhead is called activity based costing systems