When companies allocate support department costs only to the producing departments, they are using the direct method of allocation. The direct method is the simplest and most straightforward way to allocate support department costs. Variable service costs are allocated directly to producing departments in proportion to each department’s usage of the service. Fixed costs are also allocated directly to the producing department, but in proportion to the producing department’s normal or practical capacity.
Exhibit 7-6 illustrates the lack of support department reciprocity on cost allocation in using the direct method. In Exhibit 7-6, we see that by using the direct method, support department cost is allocated to producing departments only. No cost from one support department is allocated to another support department. Thus, no support department interaction is recognized.
Exhibit 7-6 illustrates the lack of support department reciprocity on cost allocation in using the direct method. In Exhibit 7-6, we see that by using the direct method, support department cost is allocated to producing departments only. No cost from one support department is allocated to another support department. Thus, no support department interaction is recognized.
To illustrate the direct method, consider the data in Exhibit 7-7 on the following page. The data show the budgeted activity and budgeted costs of two support departments and two producing departments. (Note that the same data are used to illustrate the sequential method; for the time being, ignore the allocation ratios at the bottom of Exhibit 7-7 that correspond to the sequential method.) Assume that the causal factor for power costs is kilowatt-hours, and the causal factor for maintenance costs is maintenance hours. These causal factors are used as the bases for allocation. In the direct method, only the kilowatt-hours and the maintenance hours in the producing departments are used to compute the allocation ratios. The direct allocations based on the data given in Exhibit 7-7 are shown in Exhibit 7-8. (To simplify the illustration, no distinction is made between fixed and variable costs.)
Sequential Method of Allocation
The sequential (or step) method of allocation recognizes that interactions among the support departments do occur. However, the sequential method does not fully recognize support department interaction. Cost allocations are performed in step-down fashion, following a predetermined ranking procedure. This ranking can be performed in various ways. For example, a company could rank the support departments in order of the percentage of service they render to other support departments. Usually, however, the sequence is defined by ranking the support departments in order of the amount of measured by the direct costs of each support department; the department with the highest=cost is seen as rendering the greatest service.
The sequential (or step) method of allocation recognizes that interactions among the support departments do occur. However, the sequential method does not fully recognize support department interaction. Cost allocations are performed in step-down fashion, following a predetermined ranking procedure. This ranking can be performed in various ways. For example, a company could rank the support departments in order of the percentage of service they render to other support departments. Usually, however, the sequence is defined by ranking the support departments in order of the amount of measured by the direct costs of each support department; the department with the highest=cost is seen as rendering the greatest service.
Exhibit 7-9, on the following page, illustrates the sequential method. First, the support departments are ranked, usually in accordance with direct costs; here power is first, then maintenance. Next, power costs are allocated to maintenance and the two producing departments. Then, the costs of maintenance are allocated only to producing departments. The costs of the support department rendering the greatest support service are allocated first. They are distributed to all support departments below it in the sequence and to all producing departments. Then, the costs of the support department next in sequence are similarly allocated, and so on. In the sequential method, once a support department’s costs are allocated, it never receives a subsequent allocation from another support department. In other words, costs of a support department are never allocated to support departments above it in the sequence. Also note that the costs allocated from a support department are its direct costs plus any costs it receives in allocations from other support departments. The direct costs of a department are those that are directly traceable to the department.
Also read reciprocal method of allocation
To illustrate the sequential method, consider the data provided in Exhibit 7-7. Using cost as a measure of service, the support department rendering more service is power. Thus, its costs will be allocated first, followed by those for maintenance. The allocation ratios shown in Exhibit 7-7 will be used to execute the allocation. Note that the allocation ratios for the maintenance department ignore the usage by the power department, since its costs cannot be allocated to a support department above it in the allocation sequence.
Also read reciprocal method of allocation
To illustrate the sequential method, consider the data provided in Exhibit 7-7. Using cost as a measure of service, the support department rendering more service is power. Thus, its costs will be allocated first, followed by those for maintenance. The allocation ratios shown in Exhibit 7-7 will be used to execute the allocation. Note that the allocation ratios for the maintenance department ignore the usage by the power department, since its costs cannot be allocated to a support department above it in the allocation sequence.
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