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ACKNOWLEDGEMENT

I would like to acknowledge extremely valuable assistance provided by all my teachers for their
great cooperation. They provide the proper guidance and support time to time which helps me a
lot to work in such competitive environment and the timely completion of assignments. The
environment of my study centre is very good.








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ABSTRACT

This assignment from the course of Cost Accounting. My topic is Allocation of overhead for
non-manufacturing business. This ASSIGNMENT is the part of my MBA study. In the
specialization MBA, University sends/asks all the students for prepare these assignments. The
program helps the students to understand the practical conditions of different organization and
their cultures, their values, their policies, marketing and competitive strategies and also their
implementation.
My basic purpose for doing this assignment was to understand about the criteria of overhead
adjustment for non manufacturing business with relate to the case study of Allied bank Limited.
During this assignment program I get practical data from official website of Allied bank Limited.
It is very important for the student of MBA to get practical skills from any organization. For
completion of this assignment related to my topic I have collected data from different sources I
collect data through discussion with the teachers and my fellows and recommended books from
the university.










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ALLOCATION OF OVERHHEAD IN NON-MANUFACTURING BUSINESS

INTRODUCTION WITH THE ISSUE
This assignment is from the subject of Cost Accounting. Here we are going to discuss about the
challenges and obstacles that occurs during the allocation of overhead in non-manufacturing
business. Before detailed discussion about the issue we need to take view about the basics of
Overhead and criteria for the non-manufacturing business:
OVERHEAD COSTS
Overhead cost is an ongoing expense of operating a business and is usually used to group
expenses that are necessary to the continued functioning of the business, but cannot be
immediately associated with the products/services being offered as in the costs do not directly
generate profits.
Overhead cost includes indirect product cost or indirect cost of responsibility centre. Indirect
product cost is known as manufacturing overhead whereas indirect cost of responsibility centre is
known as non-manufacturing cost. Manufacturing overhead is those manufacturing costs that are
incurred to a variety of products. It cannot be traced to individual products like depreciation and
insurance of manufacturing equipment, cost of occupying, managing and maintaining a
production facility. Manufacturing overhead is the cost that could be traced to individual product
but it is not worth the trouble to like cost of lubricants and glue used. Manufacturing overhead
also include cost that is more appropriately to be treated as cost of all outputs like overtime
premium, cost of idle time, utilities cost.
Non-manufacturing cost includes customer service, marketing and research & development cost.
ALLOCATING OVERHEAD COSTS
Normally, only manufacturing overhead is allocated to products. However, depending on the
industry the business is in and to obtain more comprehensive estimates of product cost,
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management accountant may allocate non-manufacturing cost to products. One example is Apple
Co. with high research & development cost, to obtain accurate product costing, they allocate part
of the research & development cost to product cost.
ABSORPTION COSTING
Production overhead or usually refer to as manufacturing overhead, is recovered by absorbing
them into the cost of a product. This process is known as absorption costing. Absorption costing
means that all of the manufacturing costs are absorbed by the units produced. In other words, the
cost of a finished unit in inventory will include direct materials, direct labor, and both variable
and fixed manufacturing overhead. As a result, absorption costing is also referred to as full
costing or the full absorption method.
Absorption costing is often contrasted with variable costing or direct costing. The fixed
manufacturing overhead costs are not allocated or assigned to (not absorbed by) the products
manufactured under variable or direct costing. Variable costing is often useful for managements
decision-making. However, absorption costing is often required for external financial reporting
and for income tax reporting.
Absorption costing includes 3 stages, namely apportionment of overheads, reapportionment or
allocation of service (non-production) cost centre overheads and also absorption of overhead.
For apportionment of overheads, there are no hard and fast rules for which basis of
apportionment to use except that whichever method is used to apportion overheads, it must be
fair. Unlike direct cost, indirect cost is usually allocated to cost objects and is not directly traced
to cost objects. Cost object is defined as item that is assigned separate measure of cost. To
facilitate allocation of overhead cost, overhead cost that have common allocation base is pooled
together and is known as cost pool. For each cost pool, bases of apportionment are chosen. Bases
of apportionment are some factors or variables that allow us to allocate costs in a cost pool to
cost objects. The selection of the base of apportionment should be on causal-and-effects grounds,
which mean it should be a cost driver. Some examples of bases of apportionment include floor
area, net book value of fixed assets and number of employees. Floor area is usually used for rent
and rates overhead. It is assumed that the greater the floor space occupied by the production
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centers, the more rent, cleaning and electricity usage are consumed. Net book value of fixed
assets is used for depreciation and insurance of machinery. It is based on the assumption that -
Number of employees is used for canteen cost. The assumption is when the number of
employees increases, the canteen cost will increase.
Example:
ABC Ltd has two production departments (Assembly and Finishing) and two service
departments (Maintenance and Canteen). The following are budgeted costs for the next period:
The second stage of absorption costing is reapportionment or allocation of service cost centre
costs overhead to production cost centers. Service cost centers (departments) are not directly
involved in making products. Therefore the fixed production overheads of service cost centers
must be shared out between the production cost centers using suitable basis. Examples of service
cost centers or also referred to as support department cost centers include maintenance
department, payroll department, stores and canteen. In contrast to operating or production
department which engages in production of the products and directly adds value to a product or
service, support or service department provides the service that assist and complements the
smooth functioning of the production departments in the company.
Methods of allocating support or service department cost to production department include direct
method, step-down method and reciprocal method.
DIRECT METHOD
The direct method is the most widely-used method where it allocates each service departments
total costs directly to the production departments. It ignores the fact that service departments
may also provide services to other service departments. Under this method, there is no
interaction between service departments prior to allocation.
Example:
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Machining and Assembly are the only production departments that used the services of the
Human Resources Department in March. Costs from Human Resources are allocated based on
the number of new hires. Machining hired seven employees in March and Assembly hired three
employees. Human Resources incurred total costs of RM93, 000 in March.
Allocation of H.R. Department costs to Machining:70% of RM 93,000 = RM 65,100
Allocation of H.R. Department costs to Assembly:30% of RM 93,000 = RM 27,900
No information is necessary about whether any service departments utilized services of the
Human Resources Department is the characteristic feature of the direct method. It does not take
account whether no other service department hired anybody, or whether three other service
departments each hired five employees (implying that more than 50% of the hiring occurred in
the service departments). Service department to service department services are ignored, and no
costs are allocated from one service department to another when using the direct method.
STEP-DOWN METHOD
Thestep-down methodor known as sequential method allocates the costs of some service
departments to other service departments. However, once a service departments costs have been
allocated, no subsequent costs are allocated back to it.
The choice of which department to start with is very important. The sequence in which the
service departments are allocated usually effects the ultimate allocation of costs to the production
departments, in that some production departments gain and some lose when the sequence is
changed. Hence, production department managers usually prefer over the sequence. The most
defensible sequence is to start with the service department that provides the highest percentage of
its total services to other service departments, or the service department with the highest costs, or
the service department that provides services to the most number of service departments, or some
similar criterion.

Example:
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Human Resources (H.R.), Data Processing (D.P.), and Risk Management (R.M.) provide
services to the Machining and Assembly production departments, and in some cases, the service
departments also provide services to each other:
The amounts in the far left column are the costs incurred by each service department. Any
services that a department provides to itself are ignored, so the intersection of the row and
column for each service department shows zero. The rows sum to 100%, so that all services
provided by each service department are charged out.
The company decides to allocate the costs of Human Resources first, because it provides services
to two other service departments, and provides a greater percentage of its services to other
service departments. However, a case could be made to allocate Data Processing first, because it
has greater total costs than either of the other two service departments. In any case, the company
decides to allocate Data Processing second.
In the table below, the row for each service department allocates the total costs in that
department (the original costs incurred by the department plus any costs allocated to it from the
previous allocation of other service departments) to the production departments as well as to any
service departments that have not yet been allocated.
After the first service department has been allocated, in order to derive the percentages to apply
to the production departments and any remaining service departments, it is necessary to
normalize these percentages so that they sum to 100%. For example, after H.R. has been
allocated, no costs from D.P. can be allocated back to H.R. The percentages for the remaining
service and production departments sum to 92% (7% + 30% + 55%), not 100%. Therefore, these
percentages are normalized as follows:
For example, in the table above, 59.78% of RM136,000 (= RM 81,304) is allocated to Assembly,
not 55%.
The characteristic feature of the step-down method is that once the costs of a service department
have been allocated, no costs are allocated back to that service department. As can be seen by
adding RM 105,522 and RM 134,478, all RM 240,000 incurred by the service departments are
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ultimately allocated to the two production departments. The intermediate allocations from
service department to service department improve the accuracy of those final allocations.
RECIPROCAL METHOD
Thereciprocal method is the most accurate among the three methods for allocating service
department costs. It is because it recognizes reciprocal services among service departments.
However, it is also the most complicated method, because it requires solving a set of
simultaneous linear equations.
Using the data from the step-down method example, the simultaneous equations are:
H.R. =RM80,000 + (0.08 x D.P.)
D.P. =RM 120,000 + (0.20 x H.R.)
R.M. = RM40,000 + (0.10 x H.R.) + (0.07 x D.P.)
Where the variables H.R., D.P. and R.M. represent the total costs to allocate from each of these
service departments. For example, Human Resources receive services from Data Processing, but
not from Risk Management. 8% of the services that Data Processing provides, it provides to
Human Resources. Therefore, the total costs allocated from Human Resources should include not
only the RM 80,000 incurred in that department, but also 8% of the costs incurred by Data
Processing. Solving for the three unknowns (which can be performed using spreadsheet
software):
To illustrate the derivation of the amounts in this table, the RM36,423 that is allocated from
Human Resources to Machining is 40% of H.R.s total cost of RM 91,057.
DIFFERENCES BETWEEN METHODS AND PROBLEMS USING THE METHODS
Direct method allocates support cost only to operational departments and there in no interaction
between support departments prior to allocation. On the other hand, step down method allocates
support costs to other support departments and to operating departments that partially recognizes
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the mutual services provided among all support departments. Under this method, there is one-
way interaction between support departments prior to allocation. Reciprocal method allocates
support department costs to operating departments by fully recognizing the mutual services
provided among all support departments. It is full two-way Interaction between support
departments prior to allocation.
Direct, step-down and reciprocal methods of support department cost allocation gave slightly
different total overhead cost and overhead rates for each production department. It is because of
the different recognition that each method gives to support relationships. The direct method does
not recognize any relationships that exist between support departments whereas step-down
method gives only partial recognition to these relationships.
Reciprocal method gives the most accurate results when allocating of multiple service
departments costs to operating departments. The power of reciprocal method over other
methods (direct method, step-down method) lies in its considering the mutual services provided
among all service departments which means the costs of service departments are allocated to
each service department (except the service provider) besides operating departments.
However the application of this more powerful method is rare. It is because it is more
complicated than other methods and it requires sophisticated computer aid. Some firms that use
ERP software since this method requires additional modification in coding. Therefore most of
the companies prefer employing either of direct or step down methods. Reciprocal method
considers mutual services provided among all service departments, direct method and step-down
method ignore this point. Moreover service department cost used by other service departments
are also ignored in direct method. The drawback of direct method is partially reduced by step-
down method by following a hierarchy among service departments while considering cost
allocation.
There is a ranking among service departments as to which department to begin allocation
according to different rules which in turn yields different allocation figures. The drawback of
step-down method to reciprocal method is that once the cost accumulated in the first in ranking
service department is allocated, that department does not take any share from other service
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departments. Two main rules determine the raking. The first approach considers the number of
departments served by the service departments to judge on which service department to begin
allocation and which ones to move on. The service department that serves to the highest number
of departments is the first department to begin allocation. In case of more than one department
serve the highest number of departments, the department with highest accumulated costs is the
first in the ranking and so on.
The second approach adopts the percentage of service in determining the ranking of service
department to begin with and to carry on. The service department with highest percentage of
service to other departments is the first in the ranking and so on. In case of more than one
department with equal the highest service percentage, the one with higher accumulated costs is
set as the first and so on.
Lastly reciprocal method or algebraic allocation method (REC) considers all served departments
including service departments and operating departments by a service department except the one
whose costs are allocated. There is a two way interaction among service departments unlike step-
down method. The method yields equations with multiple unknowns which are equal to the
number of service departments since the method considers all the costs of the service
departments to be allocated. As the number of service departments increase the number of
equations with multiple unknowns increase and hence a computer aid is required to solve the
equations simultaneously.
CONCLUSION
Out of the 3 allocation methods to allocate service/ support department cost to production
department cost, reciprocal method is said to be the most precise method. It is also the most
complicated method as it requires solving a set of simultaneous linear equations. However, direct
and step-down methods are simple to compute and easy to understand. Nonetheless, direct
method is the most widely used in industry. Direct method allocates each service departments
total costs directly to the production departments, and ignores the fact that service departments
may also provide services to other service departments. The direct method and step-down
method have no advantages over the reciprocal method except for their simplicity, and the step-
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down method is sometimes not very simple. Nevertheless, the reciprocal method is not widely
used. Given advances in computing power, the reciprocal method would seem to be accessible to
many companies that are not using it. Presumably, these companies believe that the benefits
obtained from more accurate service department cost allocations do not justify the costs required
to implement the reciprocal method.



CASE STUDY
ALLIED BANK LIMITED
INTRODUCTION
The function of commercial banking and application of the fundamental principles of the
depositor bank relationship have remained essentially the same since about 500 B.C. Bank
operation methods and procedures, on the other hand, have undergone a constant process of
evolution because of economic growth, the mounting volume of transactions and greater use of
banking facilities. As a result of these contributing factors, methods and practices necessary to
handle the increased volume of detail work have been developed while an other and quicker
methods have been adopted in order to cope with the increased volume, much of which has been
accomplished without unduly increasing the cost of doing business. During the last twenty years
we have experienced a constant transition from the old the new from manual to mechanical
methods and procedures from old established practices to current techniques and to a more
scientific approach to the solution of problems brought about by day to day changes in business
practices.
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About Allied Bank
Allied Bank Limited was the first bank to be established in Pakistan. It started out in Lahore by
the name Australasia Bank before independence in 1942; was renamed Allied Bank of Pakistan
Limited in 1974 and then Allied Bank Limited in 2005.
In August 2004, because of capital reconstruction, the Banks ownership was transferred to a
consortium comprising Ibrahim Leasing Limited and Ibrahim Group. Today, with its existence of
over 60 years, the Bank has built itself a foundation with a strong equity, assets and deposit base.
It offers universal banking services, while placing major emphasis on retail banking. The Bank
also has the largest network of over 700 online branches in Pakistan and offers various
technology-based products and services to its diverse clientele.
The consumer portfolio, comprising the debit card, credit cards, auto loans, personal loans and
mortgages will be established phase by phase. However, we are confident that our strengths,
together with our largest network of online branches, a superior technology platform, a big
customer base and the Consumer Personal Banking Group (CPBG), will take the Banks
profitability to new heights.
Consumers
In line with the Banks aim to provide a host of products and services to its customers,
substantial ground work has been done to establish a strong consumer banking business.
Furthermore, to achieve this objective, professionals from across the industry have been recruited
into areas of product development, sales, credit policy, research, consumer analytics, call centers
and service quality departments.
Banking system of ABL today
The banking business as we know it today is composed of three separate and distinct principal
functions.
1- The acquiring of funds to invest and loan.
2- The investing of such funds in loans and bonds.
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3- The servicing of such funds, such as providing of checking/saving facilities, and the
collection of draft, notes and checks.
These functions, while differing in detail of operation, follow the same principles established
hundreds of years go by money lenders and exchangers.
STRUCTURE AND MANAGEMENT SYSTEM OF ABL
Management system of ABL
Successful and profitable banking management depends on two principal factors.
a) The manner in which the functions of banking, that is the acquiring of deposits the
investing or converting such deposits into earning assets, and the servicing of such deposits, are
performed.
b) The degree to which officers and employees contribute their talents to the progress and
welfare of the bank in discharging duties and responsibilities.
Allied Bank Management.
Banks are managed by board of director or similar group of men who are responsible to the
owners, creditors and the government for the well being of their institutions. The government
selects all or some of directors of ABL. Management of ABL are given as follows.
Suggested Aspects for Performance in ABL
Professionals suggests improved performance might result from improvements in one or more of
the following four aspects:
1. Organizational stability
Is in regard to whether services are consistently delivered and the organization survives.
2. Financial stability
Is based especially on short-term survival, for example, the ability to pay its bills. Financial
stability is often ignored as an area of importance during capacity building.
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3. Program quality (products and services)
Is based on indicators of impact, including adequate research about effective programs and an
outcomes management system. This aspect also is often ignored.

4. Organizational growth
Is based on attracting resources and providing more services. Blumenthal adds that growth alone
is not an indicator of performance.
Ongoing Activities of Performance Management in ABL
Achieving the overall goal requires several ongoing activities, including identification and
prioritization of desired results, establishing means to measure progress toward those results,
setting standards for assessing how well results were achieved, tracking and measuring progress
toward results, exchanging ongoing feedback among those participants working to achieve
results, periodically reviewing progress, reinforcing activities that achieve results and intervening
to improve progress where needed. Note that results themselves are also measures. Note that
these general activities are somewhat similar to several other major approaches in organizations,
e.g., strategic planning, management by objectives, Total Quality Management, etc. Performance
management brings focus on overall results, measuring results, focused and ongoing feedback
about results, and development plans to improve results. The results measurements themselves
are not the ultimate priority as much as ongoing feedback and adjustments to meet results.
The steps in performance management are also similar to those in a well-designed training
process, when the process can be integrated with the overall goals of the organization. Trainers
are focusing much more on results for performance. Many trainers with this priority now call
themselves performance consultants.
Basic Steps
Various authors propose various steps for performance management. The typical performance
management process includes some or all of the following steps, whether in performance
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management of organizations, subsystems, processes, etc. Note that how the steps are carried out
can vary widely, depending on the focus of the performance efforts and who is in charge of
carrying it out. For example, an economist might identify financial results, such as return on
investment, profit rate, etc. An industrial psychologist might identify more human-based results,
such as employee productivity.
The following steps are described more fully in the topics Performance Plan,
Performance Appraisal and Development Plan, including through use of an example application.
The steps are generally followed in sequence, but rarely followed in exact sequence. Results
from one step can be used to immediately update or modify earlier steps. For example, the
performance plan itself may be updated as a result of lessons learned during the ongoing
observation, measurement and feedback step.
The following steps occur in a wide context of many activities geared towards performance
improvement in an organization, for example, activities such as management development,
planning, organizing and coordinating activities.
1. Review organizational goals to associate preferred organizational results in terms of units of
performance, that is, quantity, quality, cost or timeliness (note that the result itself is therefore a
measure)
2. Specify desired results for the domain -- as guidance, focus on results needed by other
domains (e.g., products or services need by internal or external customers)
3. Ensure the domain's desired results directly contribute to the organization's results
4. Weight, or prioritize, the domain's desired results
5. Identify first-level measures to evaluate if and how well the domain's desired results were
achieved
6. Identify more specific measures for each first-level measure if necessary
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7. Identify standards for evaluating how well the desired results were achieved (e.g., "below
expectations", "meets expectations" and "exceeds expectations")
8. Document a performance plan -- including desired results, measures and standards
9. Conduct ongoing observations and measurements to track performance
10. Exchange ongoing feedback about performance
11. Conduct a performance appraisal (sometimes called performance review)
12. If performance meets the desired performance standard, then reward for performance (the
nature of the reward depends on the domain)
13. If performance does not meet the desired performance standards, then develop or update a
performance development plan to address the performance gap* (See Notes 1 and 2)
14. Repeat steps 9 to 13 until performance is acceptable, standards are changed, the domain is
replaced, management decides to do nothing, etc.
Pay for Performance Programs in Allied Bank Limited
In addition to pay for performance programs, ABL bank rewards employees in a number of
different ways, including:
Bonus programs
Commission programs
Executive pay programs
Individual incentives
Many companies have heard of compensation consulting and wonder what it is and what it can
do for them. Compensation consulting is an intricate process of determining the best salary and
incentive options for each business. Pay for performance sounds right. It aligns managers and
investors. It has been the gold standard for compensation at least since proponents of agency
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theory 25 years ago began advocating the use of stock options in compensation packages. Its use
is a source of praise in the evaluation of governance by rating agencies that provide guidance to
shareholders in proxy voting.
As a result, pay for performance is almost universally employed in the Pakistan and increasingly
elsewhere, even though the forms it takes ebb and flow. But now questions are being raised
about whether pay for performance at its core is fatally flawed or at least misused.
ALLOCATING OVERHEAD COSTS
Normally, only manufacturing overhead is allocated to products. However, depending on the
industry the business is in and to obtain more comprehensive estimates of product cost,
management accountant may allocate non-manufacturing cost to products. One example is Apple
Co. with high research & development cost, to obtain accurate product costing, they allocate part
of the research & development cost to product cost.
Absorption costing is often contrasted with variable costing or direct costing. The fixed
manufacturing overhead costs are not allocated or assigned to (not absorbed by) the products
manufactured under variable or direct costing. Variable costing is often useful for managements
decision-making. However, absorption costing is often required for external financial reporting
and for income tax reporting.
CONCLUSION AND RECOMMENDATION
Normally, only manufacturing overhead is allocated to products. However, depending on the
industry the business is in and to obtain more comprehensive estimates of product cost,
management accountant may allocate non-manufacturing cost to products. One example is Apple
Co. with high research & development cost, to obtain accurate product costing, they allocate part
of the research & development cost to product cost.
Job satisfaction is very much important function everywhere and for every type of organization.
In ABL there are also some kind of special staff that manage the human resource matter, there
are also some special reports written in the end of the every month concerned with the
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performance matter and when financial year is closed the reports shows the overall performance
of the employee, as same procedure that are mentioned above in the assignment. Bank are
Paying the special packages and benefits to employees according to the performance of
employees that we discussed above and due to this payment base system bank achieve the extra
productivity after starting the system.

REFERENCES
1. Aivazian, Dani. Performance Rewards. Stanford University. Retrieved from
http://med.stanford.edu/dfa/documents/Stanford-performance-management-101309.pdf
on 17 November 2010.
2. www.abl.com.pk
3. Milgram, S. (1963). Behavioral study of obedience. Journal of Abnormal and Social
Psychology, 72, 207-217.
4. http://en.wikipedia.org/wiki/Allied-Bank