SERVICE COST ALLOCATION

PREPARED BY: CRISTOPHERSON A. PEREZ, CPA

ALLOCATION OF SERVICE DEPARTMENT COSTS

 Service or support department is a unit in an organization that contributes in a very

indirect way to the conversion of raw materials into a finished product.
 However, a service department does provide a service that enables the organization’s
production process to take place. These units are the purchasing, personnel,
warehousing, and maintenance department. Since these departments support the
production department, the costs incurred must be allocated to production department
to determine the full costs of a product.
POSSIBLE BASES OF ALLOCATING SERVICE COSTS
Types of Cost Allocation Base
a. Personnel cost Number of employees, direct labor costs or
Number of new hires
b. Maintenance costs Number of machine hours
c. Administration costs Peso value of assets employed
d. Research & Development costs Assets employed, new products developed or
estimated time or usage
e. Cafeteria Costs Number of employees
f. Public relations & Corporate Function Amount of sales
g. Legal costs Assets employed
h. Warehousing costs Area occupied
i. Materials & Storeroom costs Number of materials move
j. Power costs Kilowatt hours used
k. Engineering costs Number of hours utilized
l. Shipping costs Number of orders shipped
m. Purchasing costs Number of purchase orders or peso value of
purchase order
METHODS OF ALLOCATING SERVICE COSTS

 Direct method: Allocates service costs directly to production departments only and does not consider
the services provided by one service department to another. This is the most widely used method.
 Step method/Sequential allocation method: allocates service costs step by step. In some problems,
sequence might be given; hence, the given sequence shall be followed. If silent, service departments
are first ranked according to the amount of service rendered and received. The service department that
renders the highest percentage of total services to other service departments is ranked first. Once
cost has been allocated to a service department, no other service department’s cost is allocated back to
that department.
 Algebraic/Simultaneous/Reciprocal method: uses algebraic equations. All service departments are
allocated with costs from the other service departments.
ILLUSTRATION

AJD Company has two service departments (A and B) and two producing departments (X and Y). Data provided
are as follows:

Required:
1. Calculate the allocation of the service costs to Departments X and Y using the three methods of allocation.
2. Compute for the total cost of Department X and Y after service cost allocation.
SOLUTION: DIRECT METHOD
SOLUTION: STEP/SEQUENTIAL METHOD
SOLUTION: ALGEBRAIC/SIMULTANEOUS/RECIPROCAL METHOD
In algebraic method, all service cost departments get their share of service costs from the other
service departments.

Let "A" represent the total cost to be allocated from Department A.

Let "B" represent the total cost to be allocated from Department B.

To put these variables into equations:

A = 150 + 20% (B)

B = 300 + 40% (A)

The sequence of the allocation will not matter under this method. Any sequence will yield the same
amount.
SOLUTION: ALGEBRAIC/SIMULTANEOUS/RECIPROCAL METHOD

We can do the substitution method of computing for two-variable algebraic equations:

SOLUTION: ALGEBRAIC/SIMULTANEOUS/RECIPROCAL METHOD
REFERENCES:

 Dayag, A.J. (2015). Practical Accounting 2015 Edition. GIC Enterprises & Co., Inc.
 Rante, G.A. (2016). Cost Accounting. Millenium Books, Inc.
THANK YOU.