Service Department Cost

Allocations
APPENDIX 4B

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

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 4B-2

Operating Departments
An operating department carries out the central
purpose of the organization. Examples of
operating departments include:

The
The Surgery Geography The
Department at Department at Production
Mount Sinai the University Departments
Hospital. of at Mitsubishi.
Washington.

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 4B-3

Service Departments
Service departments do not directly engage in
operating activities. They provide services or
assistance to the operating departments. Examples
of service departments include:

The Accounting The Human Resources

Department at Macy’s. Department at
Walgreens.
The Cafeteria at The Internal Audit
Genesco. Department at Exxon.

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 4B-4

Interdepartmental Services

Service Operating
Department Department
Allocating service
department costs to
operating departments to
enable calculating various
types of unit costs.

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 4B-5

Allocation Approaches
Two approaches for the allocation of service
department costs to other departments are
illustrated in this appendix—the direct method
and the step-down method.

Direct  Step-Down 
Method Method

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 4B-6

Reciprocal Services

Service Service
Department 1 Department 2
When service
departments provide
services to each other
we call them reciprocal
services.

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 4B-7

Learning Objective 10

Allocate service
department costs to
operating departments
using the direct method.

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 4B-8

Direct Method

Service Operating
Interactions Department Department
between service (Cafeteria) (Machining)
departments are
ignored and all
costs are
allocated directly
to operating Service Operating
departments. Department Department
(Custodial) (Assembly)

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 Direct Method – An Example – Part
4B-9

Service Departments Operating Departments

Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Number of employees 15 10 20 30
Square feet occupied 5,000 2,000 25,000 50,000

Service Department Allocation Base

Cafeteria Number of employees
Custodial Square feet occupied

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 Direct Method – An Example – Part
4B-10

2
Service Departments Operating Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation ? ? ?
Custodial allocation ? ? ?
Total after allocation ? ? ? ?

How much of the Cafeteria and Custodial costs should be

allocated to each operating department using the direct
method of cost allocation?

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 Direct Method – An Example – Part
4B-11

3
Service Departments Operating Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 144,000 ?
Custodial allocation ? ? ?
Total after allocation $ 0 ? ? ?

20
$360,000 × = $144,000
20 + 30

Allocation base: Number of employees

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 Direct Method – An Example – Part
4B-12

4
Service Departments Operating Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 144,000 216,000
Custodial allocation ? ? ?
Total after allocation $ 0 ? ? ?

30
$360,000 × = $216,000
20 + 30

Allocation base: Number of employees

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 Direct Method – An Example – Part
4B-13

5
Service Departments Operating Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 144,000 216,000
Custodial allocation (90,000) 30,000 ?
Total after allocation $ 0 $ 0 $ 574,000 ?

25,000
$90,000 × = $30,000
25,000 + 50,000

Allocation base: Square feet occupied

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 Direct Method – An Example – Part
4B-14

6
Service Departments Operating Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 144,000 216,000
Custodial allocation (90,000) 30,000 60,000
Total after allocation $ 0 $ 0 $ 574,000 $ 976,000

50,000
$90,000 × = $60,000
25,000 + 50,000

Allocation base: Square feet occupied

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 4B-15

Learning Objective 11

Allocate service
department costs to
operating departments
using the step-down
method.

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 4B-16

Step-Down Method
Service Operating
Department Department
Once a service (Cafeteria) (Machining)
department’s costs
are allocated,
other service
department costs
are not allocated
back to it.
Service Operating
Department Department
(Custodial) (Assembly)

The allocation process is sequential and the sequence usually begins with the
department that provides the greatest amount of service to other service
departments.
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 4B-17

Step-Down Method – Key Points

There are three key points to understand regarding the step-
down method:
1. In both the direct and step-down methods, any amount of
the allocation base attributable to the service department
whose cost is being allocated is always ignored.
2. Any amount of the allocation base that is attributable to a
service department whose cost has already been allocated is
ignored.
3. Each service department assigns its own costs to operating
departments plus the costs that have been allocated to it
from other service departments.

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 Step-Down Method Example – Part
4B-18

1
Recall the data used in the direct method example.

Service Departments Operating Departments

Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Number of employees 15 10 20 30
Square feet occupied 5,000 2,000 25,000 50,000

Service Department Allocation Base

Cafeteria Number of employees
Custodial Square feet occupied

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 Step-Down Method Example – Part
4B-19

2
Service Departments Operating Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation ? ? ? ?
Custodial allocation ? ? ?
Total after allocation ? ? ? ?

Allocate Cafeteria costs first since

it provides more service than Custodial.

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 4B-20

Step-Down Method Example – Part 3

Service Departments Operating Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 60,000 ? ?
Custodial allocation ? ? ?
Total after allocation $ 0 ? ? ?

10
$360,000 × = $60,000
10 + 20 + 30

Allocation base: Number of employees

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 Step-Down Method Example – Part
4B-21

4
Service Departments Operating Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 60,000 120,000 ?
Custodial allocation ? ? ?
Total after allocation $ 0 ? ? ?

20
$360,000 × = $120,000
10 + 20 + 30

Allocation base: Number of employees

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 Step-Down Method Example – Part
4B-22

5
Service Departments Operating Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 60,000 120,000 180,000
Custodial allocation ? ? ?
Total after allocation $ 0 ? ? ?

30
$360,000 × = $180,000
10 + 20 + 30

Allocation base: Number of employees

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 Step-Down Method Example – Part
4B-23

6
Service Departments Operating Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 60,000 120,000 180,000
Custodial allocation (150,000) ? ?
Total after allocation $ 0 $ 0 ? ?

New total = $90,000 original Custodial cost

plus $60,000 allocated from the Cafeteria.

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 Step-Down Method Example – Part
4B-24

7
Service Departments Operating Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 60,000 120,000 180,000
Custodial allocation (150,000) 50,000 ?
Total after allocation $ 0 $ 0 $ 570,000 ?

25,000
$150,000 × = $50,000
25,000 + 50,000

Allocation base: Square feet occupied

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 Step-Down Method Example – Part
4B-25

8
Service Departments Operating Departments
Cafeteria Custodial Machining Assembly
Departmental costs
before allocation $ 360,000 $ 90,000 $ 400,000 $ 700,000
Cafeteria allocation (360,000) 60,000 120,000 180,000
Custodial allocation (150,000) 50,000 100,000
Total after allocation $ 0 $ 0 $ 570,000 $ 980,000

50,000
$150,000 × = $100,000
25,000 + 50,000

Allocation base: Square feet occupied

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 4B-26

Reciprocal Method: A Definition

The reciprocal method gives full recognition

to interdepartmental services. While the step-
down method only allocates costs forward –
never backwards – the reciprocal method
allocates costs in both directions. Reciprocal
allocation requires the use of simultaneous
linear equations and is beyond the scope our
book.

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 4B-27

Quick Check Data

for Direct and Step-Down Methods
Service Departments Operating Departments
ADMIN BACS Accounting Others
Departmental costs
before allocation $ 180,000 $ 90,000 $ 190,000 $ 900,000
Number of employees 15 5 20 80
Number of PCs 12 20 18 102

The direct method of allocation is used.

Allocation bases:
 Business school administration costs (ADMIN):
Number of employees
 Business
Administration computer services (BACS):
Number of personal computers
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 4B-28

Quick Check 1
How much cost will be allocated from
Administration to Accounting?
a. $ 36,000
b. $144,000
c. $180,000
d. $ 27,000

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 4B-29

Quick Check 1a
How much cost will be allocated from
Administration to Accounting?
a. $ 36,000
b. $144,000
Service Departments Operating Departments
c. $180,000
d. $ 27,000 ADMIN BACS Accounting Others
Departmental costs
before allocation $ 180,000 $ 90,000 $ 190,000 $ 900,000
ADMIN allocation (180,000) 36,000 144,000

20
$180,000 × = $36,000
20 + 80

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 4B-30

Quick Check 2
How much total cost will be allocated from ADMIN
and BACS combined to the Accounting
Department?
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500

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 4B-31

Service Departments Operating Departments

Quick CheckADMIN
2a BACS Accounting Others
Departmental costs
Howallocation
before much total cost will$ be
$ 180,000 allocated
90,000 from$ 900,000
$ 190,000
ADMIN allocation (180,000) 36,000 144,000
ADMIN
BACS allocation
and BACS combined
-
to
(90,000)
the Accounting
13,500 76,500
Department?
Total after allocation $ - $ - $ 239,500 $ 1,120,500
a. $ 52,500
b. $135,000
c. $270,000
d. $ 49,500

18
$90,000 × 18 + 102 = $13,500

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 4B-32

Quick Check Data

Service Departments Operating Departments
ADMIN BACS Accounting Others
Departmental costs
before allocation $ 180,000 $ 90,000 $ 190,000 $ 900,000
Number of employees 15 5 20 80
Number of PCs 12 20 18 102

The step-down method of allocation is used.

Allocation bases:
 Business school administration costs (ADMIN):
Number of employees
 Business
Administration computer services (BACS):
Number of personal computers

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 4B-33

Quick Check 3
How much total cost will be allocated from ADMIN
and BACS combined to the Accounting
Department?
a. $35,250
b. $49,072
c. $18,000
d. $26,333

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 4B-34

Quick Check 3a
How much total cost will be allocated from
ADMIN and BACS combined to the Accounting
Department?
a. $35,250
b. $49,072
c. $18,000
Service Departments Operating Departments
d. $26,333
ADMIN BACS Accounting Others
Departmental costs
before allocation $ 180,000 $ 90,000 $ 190,000 $ 900,000
ADMIN allocation (180,000) 8,571 34,286 137,143
BACS allocation - (98,571) 14,786 83,786
Total after allocation $ - $ - $ 239,072 $ 1,120,929
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 4B-35

End of Chapter 4B

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