“Step” overhead apportionment method: introduction; steps; example; advantages and disadvantages
Introduction
The following definitions substantiates for us the in-depth argument for “step” overhead apportionment method which is a type of non-reciprocal overhead apportionment method.
1.1.1 Definition-1
“Step” overhead apportionment method is a secondary or non-reciprocal overhead cost distribution method whereby the overhead costs associated with the service department(s) are charged to the respective production department(s) on a step-by-step basis.
1.1.2 Definition 3
Non-Reciprocal Overhead Apportionment Method is a method of distributing overhead costs amongst departments in a straight away manner without considering those service departments which reciprocally serve one another an equal way or manner. For example, department “One” uses its resources to serve department “Two” and on the other hand, equally or almost equally the latter department (of course Two) uses its resources to serve department “One”. This reciprocal relationship is not incorporated in this manner of overhead cost distribution.
No consideration of inter-services between or amongst service departments themselves. Such that even if there is a service department serving another service department, no re-distribution of such overhead costs to the respective service department. This method is the opposite of the reciprocal overhead apportionment methods.
Steps of step overhead apportionment method
The following SEVEN simple procedures are helpful when apportioning overhead cost using the step method.
Step 1: Rank the service departments based on serviceable level of each.
Assess the level of serviceable levels of each service department to the recipient departments. That is both the production and service departments and rank them starting with the highly serviceable to the least serviceable one.
NB: Serviceable viewpoint means the service department which is most vibrant in providing its services to the recipient departments based on the apportionment base under consideration. For instance, the repair and maintenance service department are more serviceable in transport affiliated organization as compares to fire prevention service department. So, in this case, the repair and maintenance department are ranked first and fire prevention service department is last for it is relied upon only when we have fire breakouts. This ranking forms a ladder like a model when apportioning overhead costs.
Step 2: Identify the most appropriate overhead apportionment base for each service department.
Select the most suitable base that govern how service is provided by the corresponding service department to the other departments.
Step 3: Summation of overhead costs for each service department.
Add up all the overhead costs associated to each respective service department. This is in preparedness to distribute the costs to the respective production Centre or departments.
Step 4: Distribution of overhead costs of the first position ranked service department.
Distribution of overhead costs of the first highly ranked service department to both production department and service departments (s) except itself. In this case, the appropriate base is used.
Step 5: Distribution of overhead costs of the second position ranked service department.
Distribution of overhead costs of the second ranked service department to both production department and service departments (s) except itself. In this case, the appropriate base is used.
Step 6: Distribution of overhead costs of the third position ranked service department.
Distribution of overhead costs of the third service department to both production department and service departments (s) except itself. In this case, the appropriate base is used.
Step 7: Distribution of overhead costs of the Nth first position ranked service department.
Distribution of overhead costs of the Nth service department to both production department and service departments (s) except itself. In this case, the appropriate base is used.
NB1: When STEP approach is used, the original overhead cost of the 1st ranked position service department is exhaustively distributed to other production and service departments.
NB2: The next 2ndhighly position ranked service department original plus service department one overhead cost is again exhaustively distributed to other production and service departments.
NB3: The next 3rd highly position ranked service department original plus service department one and two overhead cost is again exhaustively distributed to other production and service departments.
NBn: The next Nth highly position ranked service department original plus service department one, two up to Nth overhead cost is again exhaustively distributed to other production and service departments. Such that this last service department has zero balance of overhead cost.
Example
Better Horizon co. ltd. is a ghee manufacturing firm in USA. The company has three production and four service departments. The following information was provided to you to carry out a step overhead apportionment of the respective overheads to the respective production departments. The information is summarized on this table below
Required
i). Using step overhead cost apportionment method, distribute the service department overhead costs across all the departments.
Solution
Advantages of step overhead apportionment method
1). Objectivity is high.
Step overhead apportionment method uses a mathematical model and therefore it is unbiased on estimating the overhead cost for each department.
2). Accurate in assigning overhead costs.
Step overhead apportionment method is more accurate for it ensures exhaustion of the previous service department overhead cost. This means all such costs are fully transferred to the respective production department.
3). Help in setting the selling price.
Step overhead apportionment method is the tool to determine the appropriate price of a good.
4). Less confusing or conflicting
Step overhead apportionment method is a step-by-step approach as the name suggests and therefore it is easy to use although it may appear long.
5). Logical method
Step overhead apportionment method is more practical than direct method of secondary distribution because it factors all types of bases that are applicable to the cost driver.
Disadvantages of step overhead apportionment method
1). It partially ignores the inter-service department apportionments.
Unlike the reciprocal method, the step overhead apportionment method half way considers inter-service distribution while on the other side it does not. This may result to omissions of the overhead cost being distributed. Hence adversely affect pricing policy.
2). Cumbersome to compute
Step overhead apportionment method is complicated and time consuming as compared to direct method. This makes this approach unpopular amongst many industrialists.
3). High risk of wrong interpretation of the results
Step overhead apportionment method is prone to grave mistakes especially when the manual approach of computing the amount of overhead to charge.
