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Support Dept Cost Allocation - 3 Allocation Methods

The document discusses three approaches to allocating the costs of support departments to other departments: direct, step, and reciprocal. The direct method ignores services between support departments. The step method partially accounts for these services in a sequential manner. The reciprocal method fully recognizes interdepartmental services by allocating costs between support departments using simultaneous equations.

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Sophie Pearson
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175 views6 pages

Support Dept Cost Allocation - 3 Allocation Methods

The document discusses three approaches to allocating the costs of support departments to other departments: direct, step, and reciprocal. The direct method ignores services between support departments. The step method partially accounts for these services in a sequential manner. The reciprocal method fully recognizes interdepartmental services by allocating costs between support departments using simultaneous equations.

Uploaded by

Sophie Pearson
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Support-Department Cost Allocation Methods

(Text, pp. 334 – 345)

Many companies have multiple support-departments, and they frequently interact (i.e., receiving and providing
services to each other). Services that support-departments provide to each other are called “interdepartmental”
or “reciprocal” services. 3 approaches are used to allocate the costs of support-departments to other
departments.

1. Direct Method
: Ignores reciprocal services. Service department costs are allocated only to production departments –
bypassing other service departments.

– Logic: since all support-department costs are ultimately allocated to production departments anyway, an
interim allocation between support-departments is an unnecessary complication.

– Pros: simple and straightforward to apply; easy to understand.

– Cons: less accurate than the other methods since it does not consider interdepartmental services (may
lead to distorted product or service costs).

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[Example] The following data show the actual activity and costs of two support departments and two production
departments.
Support Dept. Production Dept.
Personnel Maintenance Grinding Assembly Total

Dept. Costs $250,000 $160,000 $100,000 $60,000 $570,000


# of Employees 10 20 50 30 110
Maintenance Hrs. 100 350 360 540 1,350

The overhead costs of Personnel Department are allocated on the basis of employees; those of
Maintenance Department are allocated on the basis of maintenance hours. Allocate the support-service costs to
the production departments using (1) the direct method, (2) the step method, and (3) the reciprocal method.

Total Alloc. Base for P-Costs = Total Alloc. Base for M-Costs =

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2. Step (Sequential) Method
: Takes some reciprocal services into account, but not all of them. Cost allocations are performed in step
down fashion, based on a predetermined order of allocation. The allocation sequence typically begins with
the department that provides the greatest amount of service to other support and production departments.
After its costs have been allocated, the process continues, step by step, ending with the department that
provides the least amount of services to other departments.

– Once a support-department’s costs are allocated, it never receives back a subsequent allocation from
another support-department.

– Except for the first support-department, the costs to be allocated from a support-department will contain
its own departmental costs (direct cost) as well as any costs received from other support departments
previously.

– Pros: more accurate than the direct method because it recognizes some interactions among the support
departments.

– Cons: Does not recognize all interactions; more difficult and time-consuming than the direct method

-3-
[Example]

Support Dept. Production Dept.


Personnel Maintenance Grinding Assembly Total

Dept. Costs $250,000 $160,000 $100,000 $60,000 $570,000


# of Employees 10 20 50 30 110
Maintenance Hrs. 100 350 360 540 1,350

Total Alloc. Base for P-Costs = Total Alloc. Base for M-Costs =

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3. Reciprocal Method
: Gives full recognition to interdepartmental services. It allocates support department costs both forward and
backward. Under this method, the usage of one support department by another is used to determine the
total cost of each support department, where the total cost reflects interactions among the support
departments. Then the new total of support department costs is allocated to the production departments.
Accordingly, it fully accounts for support department interaction.

– Requires the use of simultaneous linear equations or matrix algebra to do the allocations.

– Pros: enables the most accurate cost allocation by considering reciprocal services fully.

– Cons: the most complex and difficult way; may not be cost-effective.

-5-
[Example]
Support Dept. Production Dept.
Personnel Maintenance Grinding Assembly Total
Dept. Costs $250,000 $160,000 $100,000 $60,000 $570,000
# of Employees 10 20 50 30 110
Maintenance Hrs. 100 350 360 540 1,350

1. Summary of the % of service costs assigned to each dept.

2. Establishment of simultaneous linear equations

3. Allocation of service department costs

-6-

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