Comparison of the three methods the direct method,sequential and reciprocal

Exhibit 7-13 gives the cost allocations from the power and maintenance departments to the grinding and assembly departments using the three support department cost allocation methods. How different are the results? Does it really matter which method is used? Depending on the degree of interaction of the support departments, the three allocation methods can give radically different results. In this particular example, the di

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rect method (as compared to the sequential method) allocated $12,500 more to the grinding department (and $12,500 less to the assembly department). Surely, the manager of the assembly department would prefer the direct method and the manager of the grinding department would prefer the sequential method. Because allocation methods do affect the cost responsibilities of managers, it is important for the accountant to understand the consequences of the different methods and to have good reasons for the eventual choice.

It is important to keep a cost-benefit perspective in choosing an allocation method. The accountant must weigh the advantages of better allocation against the increased cost using a more theoretically preferred method, such as the reciprocal method. For example, about 20 years ago, the controller for the IBM Poughkeepsie plant decided that the reciprocal method of cost allocation would do a better job of allocating support department costs. He identified over 700 support departments and solved the system of equations using a computer. Computationally, he had no problems. However, the producing department managers did not understand the reciprocal method. They were sure that extra cost was being allocated to their departments, but they were not sure just how. After months of meetings with the line managers, the controller threw in the towel and returned to the sequential method which everyone did understand.

Another factor to be considered in allocating support department cost is the rapid change in technology. Many firms currently find that support department cost allocation is useful for them. However, the move toward activity-based costing and just-intime manufacturing can virtually eliminate the need for support department cost allocation. In the case of the JIT factory with manufacturing cells, much of the service (e.g., maintenance, materials handling, and setups) is performed by cell workers. Allocation is not necessary.