Hello All,
In this basic document, I am trying to differentiate between Primary and Secondary distribution of Overheads.
This is just the basic overview of overhead for those who are unable to understand the process of distribution and how it will come in terms of Allocation ( Primary or Secondary)
There are always two types of Costs,
1. Prime Cost/Direct Cost- The sub heading are as follows
a. Direct Material
b. Direct Labour
c. Direct Expenses
2. Indirect Cost/Chargeable Expenses/Overheads- The sub heading are as follows
a. Indirect Material
b. Indirect Labour
c. Indirect Expenses
Direct Cost- It is that cost which can be easily identifiable from the product. For Eg. Macdonalds Buger ( We can easily identify the cost of Bread and other Material, Cost of Labour who is making the Burger, and the Expenses which is directly connected with Buger.
It is that cost which customer have to pay.
Indirect Cost/Chargeable Expenses- It is that cost which can't be easily identifiable from the product. For Eg. Supervisor Salary, Rent, Lighting Exp, Power Exp Etc.
It is that cost in which customer needs to give his share of cost.
Lets take an example to understand this.
Suppose Macdonalds is selling the burger at cost of Rs. 10 ( Rs. 4 will be the Prime Cost & Rs. 6 will be the Overheads). Now Mr X came to Macdonalds outlet and taken one burger. He paid Rs. 10 for one burger and sit for 3 hours and other person came and taken one burger as a take away order and goes back.
Now Mr. X paid Rs. 4 for Prime cost but consumed overhead of Rs. 18 (6 Rs. per hour) and the other Person who came and taken the same burger and didn't consume the overhead but have to pay Rs. 10.
Now from this we can say that Prime cost is that cost which consumer needs to be paid and for overheads consumer needs to give his share.
Now the problem comes how to distribute the Overhead cost with Departments.
There are two types of distribution
1. Primary distribution- Whole company expenses which will distribute to all the departments
2. Secondary distribution- Only service department direct cost.
Let's take one example.
A Company is in production of Mouse. We have 2 Service department ( Canteen (S1) & Repair & Maintenance(S2) ) and 2 Production Department ( P1 and P2).
Expenses Amount Ratio S1 S2 P1 P2
Rent 40000 (1:1:1:1) 10000 10000 10000 10000
Power 10000 (2:3:4:1) 2000 3000 4000 1000
Electricity 20000 (2:3:4:1) 4000 6000 8000 2000 (Primary Distribution)
TOTAL 16000 19000 22000 13000
Direct Material 2000 1000
Direct Labour 3000 4000
Direct Expenses 1000 1000
TOTAL 22000 25000 22000 13000
(Distribution of Total service department cost to Production department is Secondary distribution of Cost. Distribute 22000 & 25000 into P1 & P2 Department.
S1 22000 1:1 (22000) - 11000 11000
S2 25000 1:1 - (25000) 12500 12500
TOTAL Nil Nil 35500 36500
Note:- There are several methods available by which we can allocate the cost of service department to Production department. Depending upon the company policy user needs to check into SAP
By this the total cost of each Service Department has allocated to Production Department.
Now if P1 department work for 10000 Machine Hour and P2 department work for 1000 Labour Hour, then by this we can identify the Per hour Machine Hour Rate and Per hour Labour Rate.
P1= 35500/10000= 3.55 Per Hour MHR
P2= 36500/1000= 36.5 Per Labour Hour.
After this we can calculate any cost with respect to any product which the company will be producing.
I hope by this document, you will be able to differentiate between Primary and Secondary distribution.
Your feedback will be appreciated.
Pankaj