Secondary distribution, in the context of cost accounting, refers to the allocation of service (or support) department costs to production departments within an organization. The process ensures that all overhead costs, even those from service departments that don’t directly contribute to production, get fully assigned to the actual products being manufactured.
Here’s a breakdown of the allocation process:
- Primary Distribution (or First Stage Allocation): In this initial step, overhead costs are collected and allocated directly to all departments, both production and service. The allocation can be based on various measures such as direct labor hours, machine hours, or square footage, among others.
- Secondary Distribution (or Second Stage Allocation): This involves allocating the overhead costs of service departments to production departments. Since service departments do not directly produce goods or services but support the production departments that do, their costs need to be further distributed to reflect the true cost of production. This step may involve multiple iterations if service departments provide services to each other.
Example of Secondary Distribution
TechMaster Electronics produces computer motherboards and graphic cards. The company has several departments:
- Production Departments: Motherboard Manufacturing and Graphic Card Manufacturing
- Service Departments: IT Support and Facility Management
Primary Distribution of Overheads: The company first allocates its overhead costs directly to all the departments:
- Motherboard Manufacturing: $300,000
- Graphic Card Manufacturing: $250,000
- IT Support: $100,000 (costs based on the number of servers and computers maintained)
- Facility Management: $150,000 (costs based on square footage)
Secondary Distribution: Now, the company has to distribute the overhead costs of the service departments (IT Support and Facility Management) to the two production departments.
- IT Support Costs Allocation:
TechMaster decides to allocate IT Support costs based on the number of computer systems used in each production department:
- Motherboard Manufacturing uses 70 computer systems.
- Graphic Card Manufacturing uses 30 computer systems.
Allocation to Motherboard Manufacturing = ($100,000 * 70) / 100 = $70,000
Allocation to Graphic Card Manufacturing = ($100,000 * 30) / 100 = $30,000
- Facility Management Costs Allocation:
Facility Management costs are allocated based on the space occupied by each department:
- Motherboard Manufacturing occupies 10,000 sq. ft.
- Graphic Card Manufacturing occupies 5,000 sq. ft.
Allocation to Motherboard Manufacturing = ($150,000 * 10,000) / 15,000 = $100,000
Allocation to Graphic Card Manufacturing = ($150,000 * 5,000) / 15,000 = $50,000
Overhead Costs after Secondary Distribution:
- Motherboard Manufacturing:
- Initial: $300,000
- From IT Support: $70,000
- From Facility Management: $100,000
- Total: $470,000
- Graphic Card Manufacturing:
- Initial: $250,000
- From IT Support: $30,000
- From Facility Management: $50,000
- Total: $330,000
After the secondary distribution, the Motherboard Manufacturing department has total overhead costs of $470,000, while the Graphic Card Manufacturing department has total overhead costs of $330,000. This allocation ensures that each product bears its fair share of the support departments’ costs, which gives a more accurate reflection of the total cost of production for each product.