Accounting for Managers: Interpreting accounting information for decision-making

ACCOUNTING DECISIONS 163

For example, a business with budgeted overhead expenditure of £100,000 and an
activity level of 4,000 direct labour hours would have a business-wide budgeted
overhead rate of £25 per hour (£100,000/4,000). Most businesses are able to identify
their overhead costs and activity to individual cost centre levels and determine
cost centre overhead rates. This can be achieved using a three-stage process:

1 Identify indirect costs with particular cost centres. In many cases, although
costs cannot be traced to products/services, they can be traced to particular
cost centres. Accounting systems will separately record costs incurred by each
cost centre. For example, supervision costs may be traceable to each cost centre.
Certain consumables may only be used in particular cost centres. Each cost
centre may order goods and services and be charged for those goods and
services separately.
2 Analyse each line item of expenditure that cannot be traced to particular cost
centres and determine a suitable method of allocating each cost across the cost
centres. There are no rules for the methods of allocation, which are contingent
on the circumstances of the business and the choices made by accountants.
However, common methods of allocating indirect costs include:
Expense Allocation basis
Management salaries Number of employees in each cost
centre
Premises cost Floor area occupied by each cost
centre
Electricity Machine hours used in each cost
centre
Depreciation on equipment Asset value in each cost centre

3 Identify those cost centres that are part of the production process and those
service cost centres that provide support to production cost centres. Allocate the
total costs incurred by service cost centres to the production cost centres using
a reasonable method of allocation. Common methods of allocating service cost
centres include:

Service cost centre Allocation basis

Maintenance Timesheet allocation of hours spent in

each production cost centre

Canteen Number of employees in each cost centre

Scheduling Number of production orders

An example of cost allocation between departments is shown below. Using the
previous example and the same overhead costs of £200,000, suitable methods of
allocation have been identified over five departments (stages 1 and 2) as follows:

Expense item Method of allocation

Indirect wages From payroll

Factory rental Floor area

Depreciation on equipment Asset value

Electricity Machine hours