I have reviewed Dave Miller’s proposal to allocate heating costs based on the square footage a particular production line occupies. I have severe reservations about using this method to capture an indirect cost such as heating. Square footage may bare no relation to how much heat is needed in an actual production area. Depending on the manufacturing process employed, an area may require more heat or less heat regardless of the area the production line occupies. Some manufacturing processes produce heat as a byproduct of the process.
For these areas less heat would be required. Other processes may generate less heat and occupy a larger area and, thus, would need more facility generated heat than a smaller production area producing more heat. Also, different areas of the facility require more heating than others. For example, areas that border the outer walls are typically colder than areas in the center of the facility. Without doing an in-depth calibration of the temperature requirements for each of the five production lines, it is impossible to accurately estimate or allocate heating to each of the five production lines.
Therefore, it is my recommendation that heating costs, like other facility generated costs that benefit all production lines, be allocated to an indirect overhead pool and be allocated based on number of units produced not square footage of the production line space. For an indirect cost of this type this would follow standard accounting procedures and principles.
My ethical concerns regarding Dave Miller’s proposal are twofold: Number one, he is counting on the production manager’s to submit their own estimates of the square footage of their production areas. Since production manager’s annual bonuses are based on their ability to control production costs they may tend to underestimate the total square footage their production lines occupy so their costs will be lower.
If this method were used to allocate heating costs, then an independent party should estimate the square footage of each manager’s production area. Number two, Dave Miller’s method simply does not follow accepted accounting principles for allocating indirect overhead costs like heating.
If heating costs are to be handled as an overhead expense, then a separate entry on the cost account ledgers should be created to capture this cost. Heating costs would then be allocated to different production lines based on units produced, each unit having the same overhead percentage applied to it to cover indirect heating costs.