Cost Allocation - From the Simple to the Sublime: Handout due by 11/6/14

After reading the attached article "Cost Allocation - From the Simple to the Sublime", please complete the questions
listed below. Any questions, please let me know.
1. Allocate the service department costs (administrative, housekeeping and maintenance costs) to the revenue
producing departments (patient rooms and diagnosis & treatment) using the Direct Allocation Method.

Administration
Housekeeping
Maintenance
Patient Rooms
Diagnosis &
Treatment

Costs

Av #
employees

% of
employees

Square Ft
of area

2,000,000
900,000
400,000
5,000,000
9,000,000

50
30
10
120
40

20
12
4
48
16

17,300,000

250

100

Costs
2,000,000
900,000
400,000
5,000,000
9,000,000

Administration
Housekeeping
Maintenance
Patient Rooms
Diagnosis &
Treatment

Administration
-2,000,000

# of
Requisitions

% of
Requisitions

40,000
10,000
20,000
120,000
60,000

% of
Square
Ft of
area
16
4
8
48
24

80
120
0
500
300

8
12
0
50
30

250,000

100

1000

100

Housekeeping

Maintenance

-900,000
1,500,000
500,000

-400,000
250,000
150,000

600,000
300,000

17,300,000

Total
0
0
0
7,350,000
9,950,000
17,300,000

2. Allocate the service department costs (administrative, housekeeping and maintenance costs) to the revenue
producing departments (patient rooms and diagnosis & treatment) using the Step Allocation Method.

Administration
Housekeeping
Maintenance
Patient Rooms
Diagnosis &
Treatment

Costs

Av #
employees

% of
employees

Square
Ft of
area

2,000,000
900,000
400,000
5,000,000

50
30
10
120

20
12
4
48

40,000
10,000
20,000
120,000

% of
Square
Ft of
area
16
4
8
48

9,000,000

40

16

60,000

17,300,000

250

100

250,000

Administration

Housekeeping

Costs

# of
Requisition
s

% of
Requisitions

80
120
0
500

8
12
0
50

24

300

30

100

1000

100

Maintenance

Total

Administration
Housekeeping
Maintenance
Patient Rooms
Diagnosis &
Treatment

2,000,000
900,000
400,000
5,000,000

-2,000,000
300,000
100,000
1,200,000

-1,200,000
120,000
720,000

-620,000
387,500

9,000,000

400,000

360,000

232,500

17,300,000

0
1,200,000
-620,000
7,307,500
17,300,000

3. Why do we allocate service department costs to production departments?

A service department such as the Maintenance Department or the Personnel Department must exist in order
for an organization to carry out its primary function. Therefore, the cost of running a service department is
part of the cost incurred by the organization in producing goods or services. In order to determine the cost of
those goods or services, all service department costs must be allocated to the production departments in
which the goods or services are produced.
4. What are the advantages and disadvantages of using the direct method of cost allocation over the step
method of cost allocation?
The direct cost allocation method is much simpler and faster than the step cost allocation method, because
it requires less information to complete. Because the costs associated with each support department are
allocated directly to the appropriate departments without regard for reciprocal services and selfconsumption. Although the direct method is simple, it is less accurate than the other methods because it
ignores interdepartmental services. This method cannot be used to allocate costs to other service
departments. . The direct method ignores the cost drivers that are related to the service departments and
concentrates only on the cost drivers attributes to the production departments. It can be used only to
allocate costs to production departments
The step cost allocation method is more accurate and in depth than the direct cost allocation method,
because it requires more information to complete, it includes at least partial consideration of reciprocal
services. You can get a much better look at the costs if you use the step cost allocation method. The
advantages of using the step cost allocation method are to produce more accurate estimations on final costs
and to evaluate the costs being assigned to other service departments. The step cost method provides for
allocation of a service departments costs to other service departments, as well as, to operating
departments. The step-cost method is sequential.
5. Which method do you feel would be the most accurate method for allocating service department costs to
their appropriate product departments?
I feel that the step cost allocation is more accurate because it takes into consideration more of the details,
and once the costs of a service department have been allocated, no costs are allocated back to that service
department. The intermediate allocations from service department to service department improve the
accuracy of those final allocations.