Why allocate service department costs

Appendix: Service Department Allocation. Search for:. Step Method of Allocation The second method of allocating service department costs is the step method. Admin Oper. Dept 1 Oper. Dept 2 Maintenance 2, 2, 3, 2, MH x 1. Dept 2 Administration 4, 2, employees x Service departments provide services and support to operating departments as well as other support departments. Examples include human resources and information systems departments. The problem in allocating service department costs is complicated by multiple-department relationships, where each service department may provide service to all of the other departments, including other service departments and itself.

The three service cost-allocation methods vary in terms of ease and accuracy because of how they approach this problem.

The direct method allocates costs to the operating departments directly, with no allocations to the other service departments. The sequential method also known as the step-down method , allocates costs to operating departments and other service departments sequentially, but only in one direction. There is no set order in the sequence used: One common technique is to begin with the service department that incurs the most costs supporting other service departments and work downward to the department with the least costs.

This method partially recognizes other service departments, which makes it more accurate than the direct method. The reciprocal method fully recognizes the other service departments by allowing reallocations back to each service department. The direct method was used most in practice until the s, when the Cost Accounting Standards Board CASB established a standard for service department cost allocation. The direct method was allowed, but only if the allocations could be considered reasonably close to the allocations resulting from the sequential method.

Today, cost accounting textbooks describe the reciprocal method with simple examples that involve repeated iterations or simultaneous equations or both to model the cost of each department. In a simple example with two service departments and two operating departments, only four simultaneous equations are needed and can be easily solved by hand.

When more than two service departments are involved, accounting textbooks recommend the use of simultaneous equations, matrix algebra, and a computer to solve the equations. Unfortunately, students and financial managers find the use of matrix algebra to be quite a challenge.

Fortunately, there is now an alternative solution using the iterative calculation option in Excel or any spreadsheet software with similar functionality to calculate the reciprocal method more easily. This method is an attractive alternative to explain and solve the service department cost allocation problem and should make the reciprocal method more accessible to managers.

Consider an example using two service departments, S1 and S2, and two operating departments, P1 and P2. Each service department provides services to the other three departments.

To keep it simple, neither S1 nor S2 consumes its own services. Figure 3 shows the reciprocal method with repeated iterations. Service department costs are reallocated back to the service departments for several rounds until the reallocated costs are reduced to near-zero amounts.

This process continues through multiple rounds until the balance in S1 is immaterial. Although allocating and reallocating service department costs through multiple rounds successfully recognizes the reciprocal relationships of these departments, this method is tedious and impractical when there are many service departments.

Visit the Bookstore. We use cookies on this site to enhance your user experience. For a complete overview of all cookies used, please see the cookie policy. Opt out of cookies. Manage consent. Close Privacy Overview This website uses cookies to improve your experience while you navigate through the website.

Out of these, the cookies that are categorized as necessary are stored on your browser as they are essential for the working of basic functionalities of the website. We also use third-party cookies that help us analyze and understand how you use this website.

These cookies will be stored in your browser only with your consent. You also have the option to opt-out of these cookies. But opting out of some of these cookies may affect your browsing experience. Necessary Necessary. Functional functional. Performance performance.

Analytics analytics. Advertisement advertisement. Others others. The cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Functional". The cookie is set by GDPR cookie consent to record the user consent for the cookies in the category "Advertisement". This cookie is provided by PayPal.

This cookie is provided by PayPal when a website is in association with PayPal payment function. The cookie is set by the GDPR Cookie Consent plugin and is used to store whether or not user has consented to the use of cookies.

This cookie is set by Google. This cookie is provided by Paypal. These cookies are set by embedded YouTube videos. This cookie is installed by Google Analytics. This cookie is set by Google and stored under the name dounleclick.