Primary and secondary distribution (Repeated distribution method)

Primary Distribution of Overheads 🧾

Primary distribution is the initial process of allocating and apportioning all overhead costs (both manufacturing and non-manufacturing, if applicable to the factory) to all departments within the factory, whether they are production departments (directly involved in making the product) or service departments (provide support to production and other departments).

• Purpose: To ensure that every overhead cost is initially assigned to a department responsible for incurring it or benefiting from it. It creates an "Overhead Distribution Summary" showing the total overheads for each department.
• Methodology:
  • Allocation: Overheads that can be directly and wholly identified with a particular department are allocated to that department. For example, the salary of a supervisor exclusively working in Department A, or the depreciation of a machine used only in Department B.
  • Apportionment: Overheads that are common to multiple departments are apportioned (distributed) among those departments using an appropriate, fair, and logical basis. For example, factory rent is apportioned based on floor area occupied by each department; electricity might be apportioned based on kilowatt-hour (KWH) readings or machine horsepower.
• Result: After primary distribution, each production department and each service department will have a total sum of overheads associated with it.

Secondary Distribution of Overheads (Reapportionment) ➡️

Secondary distribution, also known as reapportionment or inter-departmental transfer, is the process of re-distributing the overhead costs accumulated in service departments to the production departments. This step is necessary because service departments (like maintenance, power house, stores, human resources) do not directly produce goods; their costs must ultimately be borne by the products. Therefore, their accumulated overheads are transferred to the departments that directly contribute to production.

• Purpose: To ensure that all factory overheads are ultimately charged to the production departments, from where they can then be absorbed into the cost of products.
• Reason: Products do not pass through service departments, but they benefit indirectly from the services these departments provide to production departments.
• Methodology: There are several methods for secondary distribution, depending on whether service departments provide services to each other (reciprocal services) or only to production departments (non-reciprocal services).

Methods of Secondary Distribution:

1. Direct Method:

   • Concept: This is the simplest method. It ignores any services provided by one service department to another. Service department costs are directly apportioned only to production departments.
   • Pros: Easy to calculate.
   • Cons: Less accurate as it ignores inter-service department dependencies.
   • Suitability: When inter-service department services are negligible.

2. Step-Down Method (Sequential Method):

   • Concept: Service department costs are apportioned sequentially. The service department that provides services to the most other departments (or the one with the largest costs) is apportioned first. Once a service department's cost is distributed, no costs are apportioned back to it. The process continues until all service department costs are distributed to production departments.
   • Pros: More accurate than the direct method as it partially recognizes inter-service department services.
   • Cons: The sequence of distribution affects the final cost; it doesn't fully account for reciprocal services.

3. Reciprocal Service Methods: These methods fully recognize that service departments may provide services to each other.

   • a. Repeated Distribution Method (Trial and Error Method) 🔄

     • Concept: This method involves repeatedly apportioning the costs of service departments to both production and other service departments until the amounts remaining in the service departments become negligible or zero.
     • Process:
       1. Start with the service department that has the largest overhead balance or serves the most departments. Apportion its costs to all other departments (production and other service departments) based on a suitable basis.
       2. The next service department's original cost plus any amount received from the first service department is then apportioned to the remaining departments (production and other service departments).
       3. This process is repeated for all service departments.
       4. Because service departments receive costs from each other, the process creates a loop. You continue the distribution cycle (e.g., Service A to B and production, then Service B to A and production, then A again, and so on) until the amounts transferred back and forth become so small that they are insignificant.
     • Pros: More accurate than direct or step-down methods as it acknowledges reciprocal services. Relatively intuitive to understand.
     • Cons: Can be lengthy and tedious, especially with many service departments. It's an iterative process that continues until balances are negligible.
     • Example Illustration:
       • Initial Overheads: Prod Dept X: ₹10,000; Prod Dept Y: ₹8,000; Service Dept S1: ₹2,000; Service Dept S2: ₹1,500.
       • Service Ratios: S1 to X: 40%, Y: 30%, S2: 30%. S2 to X: 60%, Y: 40%.
       • Step 1 (S1's Cost):
         • Apportion S1 (₹2,000) based on its ratios:
           • X gets ₹800 (40% of ₹2,000)
           • Y gets ₹600 (30% of ₹2,000)
           • S2 gets ₹600 (30% of ₹2,000)
         • New balance for S2 = Original ₹1,500 + ₹600 = ₹2,100
       • Step 2 (S2's New Cost):
         • Apportion S2 (₹2,100) based on its ratios:
           • X gets ₹1,260 (60% of ₹2,100)
           • Y gets ₹840 (40% of ₹2,100)
           • S1 gets ₹0 (S2 doesn't serve S1 in this example, but if it did, S1 would get a share).
         • New balance for S1 = Original ₹0 (after first distribution) + ₹0 (if S2 served S1)
       • Step 3 (Re-Apportion S1's new balance): If S1 received anything from S2, you'd apportion that amount. In this case, S1's balance is 0, so the next iteration might involve S2's remaining balance or stop if all service department balances are negligible. The process repeats until the balances in service departments are negligible.

   • b. Simultaneous Equation Method:

     • Concept: This is the most accurate method for reciprocal services. It uses algebraic equations to determine the true total cost of each service department, recognizing the inter-service department transfers. Once the true total costs are found, they are then directly apportioned to production departments.
     • Pros: Mathematically precise, fully accounts for reciprocal services.
     • Cons: Requires solving simultaneous equations, which can be complex without a calculator or software for many departments.

After secondary distribution, all factory overheads will be accumulated in the production departments. These total departmental overheads are then used to calculate overhead absorption rates, which are finally applied to the products to determine their total cost.