Cost Allocation Through the Method of Sections

Understanding the Method of Sections

A method is needed that avoids arbitrariness in cost calculation and provides information useful for decision-making (the goal of Analytical Accounting). For these reasons, the organization should be divided into parts, ordering information for each part, business unit, or area of responsibility.

Homogeneous Sections

These areas of activity are called Sections. A homogeneous section is a real division of the company, formed by a combination of resources directed towards the same goal, and whose activity can be measured in physical units called work units.

Characteristics of Homogeneous Sections:

1. They are accounting entities, which doesn't mean they lack economic significance; they can often be derived from the company's organizational structure.
2. They serve as centers for the micro-allocation of costs (Responsibility Centers).
   • They aim to solve the problem of allocating indirect costs (IC) to products.
   • They establish a person responsible for the costs incurred in each section.
3. They have a common measurement unit (unit of work), which allows control of the section and the subsequent allocation of indirect costs to products.

Unit of Work

This is the unit used to measure the activity of each section (e.g., machine-hours, man-hours, etc.). Each section will have its own unit of work.

• Manufacturing Section: The most common unit of work is working time, measured either as labor hours or as machine working hours.
• Distribution Section: The most common unit of work relates to the sales volume of each product.

Aims of the unit of work:

• Allow control of the section.
• Allow the proper allocation of indirect costs to products.

Requirements for an Ideal Work Unit

For the correct allocation of Indirect Costs (IC), the work unit should ideally fulfill these requirements:

1. Be the real unit of measurement for the section's activity, meaning it must be representative of the activity itself.
2. The application of section costs (loads) to products is based on the work units consumed by each product. Therefore, it must be easily traceable or measurable in production.

Division of the Company by Sections

Sections are divided into main and auxiliary categories.

• Main Sections: These are sections whose activity is applied directly to production. Consequently, they are the ones that ultimately transfer the indirect costs by charging them to the products or services (e.g., assembly section).
• Auxiliary Sections: These are sections whose activity is directed towards other sites or sections within the company. Their costs are transferred to those other sections (this process is called Subreparto or secondary distribution). They do not work directly on the final product or service (e.g., Management Section, Maintenance Section).

Phases of Indirect Cost Distribution

The distribution of indirect costs to the sections is done in two phases:

1. Primary Distribution: Indirect costs, categorized by nature, are distributed among the different sections (both main and auxiliary). With the primary distribution, we obtain the total cost attributable to each section itself.
2. Secondary Distribution (Subreparto): This consists of redistributing the costs allocated to the auxiliary sections among the main sections, based on an appropriate distribution key or driver.