Query No. 12

 

Subject:           

Allocation of corporate office expenditure to various units.1 

A.  Facts  of  the  Case

 

1. The revenue expenditure of the corporate office of a company was being allocated to various operating units and projects under construction, based on the estimated benefits or on the basis of the expenditure relatable to the different units as decided by the management to their best assessment and judgement.  The basic principle followed by the company for allocation of  such  expenditure  has  been  the  amount  of  services  rendered  by  the corporate  office  to  various  units  under  operation  and  unit(s)  under construction.

 

2. Of  late,  due  to  paucity  of  funds  and  some  of  the  units  becoming temporarily unviable, the operations of seven units were stopped and only three units were under operation intermittently.  Though the production at most of the units had been stopped, allocation of corporate office overheads to various units was continued to be made based on allocations made in the previous years.  In other words, production at various units during the year 1999-2000 was not regular, but the allocation of corporate office overheads was made to all the units based on allocations made during the year 1998-99.

 

3. While approving the accounts of the company for the year 2000-01, the management reviewed the existing system of allocation of corporate office overheads specially to units which are not in operation at all. In this regard, the management has submitted as under:

 

(a) The corporate office has been functioning as a service centre to all the units of the company. The nature of services being rendered by the corporate office to operating units is of advisory nature at corporate level with regard to procurement of supplies, rendering technical assistance and management of working capital. The nature of services rendered to non-operating units is with regard to assisting in legal matters, financial management in respect of the salaries and other expenses, management of inventory holdings and other administrative support.  As a matter of fact, corporate office is devoting almost full time to all units for technical, legal and financial including administrative matters or otherwise.  

(b) Since only three units are presently in operation and other seven units are closed, in case corporate office overheads are allocated to three operating units only, the entire amount of corporate office expenditure will get allocated to these units only. This would lead to excessive allocation to these units, thereby distorting the financial health of the units.

4. As per the querist, from the records available, no specific arithmetical basis could be determined to suggest that corporate office overheads were allocated solely based on production capacity or manpower deployed at each unit or in combination of both.  The details of allocation of corporate office overheads in the past three years together with capacity of each plant and manpower deployed therein have been supplied by the querist separately.

 

5.  According to the querist, the change in the basis of allocation of corporate office overheads at the stage when all the units of the company are proposed to be hived off, will be subject to critical scrutiny by various agencies including statutory auditors and government auditors. In view of the above and in order to be more judicious in allocation of corporate office overheads in future, it was decided that the case may be referred to the Expert Advisory Committee of the Institute of Chartered Accountants of India.

 

B .  Query

 

6.  The querist has sought the opinion of the Expert Advisory Committee on the following issues:

 

(i)  (a)  Whether the corporate office overheads should be allocated to all the units, whether operating or non-operating, on equitable basis, as being done presently, or  

(b)Whether corporate office overheads should be allocated to units under operations only; if so, whether based on installed capacity of the plant or manpower deployed or in combination of both.  

(ii)  In case (i)(b) above is followed, what will be the treatment of the corporate office overheads in case operations in the existing three units are also stopped subsequently.

(iii)  Any other method which could be adopted for such allocation.

C.   Points  considered  by  the  Committee

 

7.  The  Committee  notes  that  the  corporate  office  of  the  company  is functioning as a  service centre  to all  the units of  the company, whether operating or non-operating, though the nature of services being provided may be different.  Thus, the Committee is of the view that the allocation of corporate  office  overheads  to  various  units,  whether  operating  or  non- operating, should be continued to be made based on the benefits derived by various units as explained in paragraph 8 below.  The basis of allocation should be reviewed under the current circumstances, particularly, as the operations of seven units have been stopped and only three units are under operation intermittently.  Thus, in the light of the facts and circumstances, the  management  should  make  the  decision  to  their  best  judgement  and assessment.

 

8.  The Committee is of the view that the rational criterion for selecting anoverhead allocation base is the extent of benefit derived from the incurrence of overhead by the consuming department/unit.  The benefits derived can be of technical, legal, administrative or financial nature.   Thus, the base for evaluation of benefits derived by the various units will be different for every particular head of expense.  For example, overheads of an EDP department can be allocated to the user departments on the basis of number of hours for which each department has used the EDP facilities.  Personnel department costs at corporate office can be allocated on the basis of number of hours devoted by the managerial personnel in rendering services to various units. Capital investment base can be considered appropriate for allocating interest. If the expenditure can not be correlated to the benefit derived by the concerned department/unit clearly, the same may be allocated on some other rational basis. Thus, separate basis of apportionment may be appropriate for different items of overheads.

 

D.  Opinion

 

9.   On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 6:

 

(i)   (a)   The corporate overheads should be allocated to all the units, whether operating or non-operating, on the basis of the benefits derived.

(b)   Please refer to (a) above.

 

(ii)  The allocation of corporate office overheads among various units would be required even if operations of all the units are stopped on the basis of the benefits derived by each unit.

 

(iii)  No method other than stated in (i)(a) above would be appropriate.

      1 Opinion finalised by the Committee on 30.5.2002.