Aug 19, 2013

Question on Allocation....

My friend Lakshman asks in our chat in GTalk: 

Lakshman: Is it mandatory to charge an expense to Cost Center? or, to recognize a revenue for a Cost Center?

I think they should be charged/ recognized at company level, NOT at CC level though Expense & Revenue are P&L items.

Otherwise, few Cost Centers (HR, IT, Purchase etc.,) will never have any revenue but they all will incur CC level expense.

But I have noticed in some companies that Expenses & Revenue are charged/ recognized at CC level. Do you recommend this is logic?

Ramaswamy: Cost Center is a terminology used in Oracle. In Normal Business, those departments which has both Revenue and Costs are known as Profit Centers and those which incur only costs are known as Cost Centers. The costs incurred by the Cost Centers are known as Indirect Overheads and at the end of the period the same are allocated to the profit centers in some ratio. This process is called mass allocation in Oracle. Once the costs are allocated through allocation, the company can identify the profitability of each department.

As you can see, since the allocation can significantly impact the profitability of each Profit Center, there is a lot of discussion and argument within the department heads on the exact allocation ratio to be assigned to each department.

Attaching Cost Center / Profit Center to each expense account brings in accountability of the expenses on the department heads. It also helps in comparison between various departments. For example, comparing the printing and stationery expenses of various departments will help the organization to track and control the expenses across the entire organization

Does this answer your question?

Lakshman: close to maximum...

Th salary of HR employees (HR Mgr, HR Officers etc.,) + their expense (Phone, business travel, stationary etc.,).. how to treat them? to apportion to all CC? or consider at company level?

another case is company vehicle..how to allocate their periodical depreciation expense to various CC? based on usage by each CC or fully at company level?

Ramaswamy: The basis used in this case is the number of employees in each department. On that basis, the HR Costs are allocated.

Lakshman: k....u mean, HR CC expenses are allocated to various CC..

Ramaswamy: Yes, HR CC expenses are allocated to the various CCs (Departments).
Company vehicle is either allocated to one Cost Center (if the amount is minimal) or allocated based on usage. (from the log book). The principle of allocation is Need for accuracy Vs. Cost

There are no hard and fast rules on basis of allocation. This differs from comapny to company

Lakshman: yes, u r tight..

formula (or the basis) for such allocation of HR CC expense is dynamic and keeps changing every month...and formula may not be acceptable by each CC as you said, since this will effect each CC profitability..

Ramaswamy: Normally the basis is decided at the beginning of the year and is signed off by various departments

Lakshman: yes..its true...
but as the business climate changes, this also will change..
and shud change..

Ramaswamy: Yes, they will undergo regular review, normally on a quarterly basis

Lakshman: reg Vehicle (an Asset)...it can be owned by a CC and can be used by multiple CC..so, dep expense will be distributed to those CC which use this Asset or simply dep expense is charged to company level..
quarterly? that makes sense..

Ramaswamy: Expenses are never charged to 'Comapny'. Normally such expenses are charged to a single cost center, normally Finance Department.

Lakshman: even Depreciation Expense?
since its a non-cash exp, I guess it shud be at company level..

Ramaswamy: Yes. In case of depreciation of Plant and Machinery, the same is charged to the Production Department and in Case of Buildings and Computer equipments some other basis like Floor Area for Buildings and Number of Computers (for IT) is used.

Also in Oracle, the Assets are already tagged to a Cost Center so that the depreciation is automatically calculated at the Cost Center Level. No need of Depreciation.

Any expense that is directly linked to a department or is directly used in Production is called 'Direct Overhead' (For example, depreciation of machinery) and others like HR Expenses are called 'Indirect Overheads'. Normally, allocation is required only for Indirect Overheads

Lakshman: ok...righte..
right*
though Asset Dep Exp is linked to a CC in Asset Category definition, Distribution Set can be used to distribute Dep Exp to multiple CC..

Ramaswamy: Yes. Normally that happens in what is known as 'Second Level' of Allocation. In the 'First Level', the costs are allocated to the Machinery and in the Second Level, the machinery costs are further allocated to the Products.

Allocating expenses to Products is called 'Inventorising'.

But of course that goes into more complexity

Does it clarify your doubts?

Lakshman: yes....yes...

Ramaswamy: OK, see you later

Lakshman: Thank you so much, ram for ur time and very good explanation..
:-)

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