11/2/2019 Step down method of cost allocation - explanation, example, advantages and disadvantages | Accounting for Management

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Step down method of cost allocation

 Posted in: Service department costing (explanations)

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Unlike direct method, the step method (also known as step down method) allocates the cost of a service department to other service departments as well
as to operating departments. The cost allocation under step method is a sequential process. It begins with the allocation of cost of the service department
that provides the greatest amount of service to other service departments and ends with the allocation of cost of the service department that provides the
least amount of service to other service departments.

Example
The Robert Company uses the step method for allocating the costs of its service departments to operating departments. The company has two service
departments and two operating departments. The selected information for the four departments is given below:

The company uses employee hours as the base for allocating the cost of department A and space occupied for allocating the cost of department B.

Required: Allocate the cost of service departments to operating departments using step down method.

Solution

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11/2/2019 Step down method of cost allocation - explanation, example, advantages and disadvantages | Accounting for Management

Allocation of department A’s cost:

Allocated to department B: $180,000 × (3/27) = $20,000

Allocated to department X: $180,000 × (9/27) = $60,000
Allocated to department Y: $180,000 × (15/27) = $100,000

Allocation of department B’s cost:

Total cost of department B: $45,000 + $20,000 = $65,000

Allocated to department X: $65,000 × (3/25) = $7,800

Allocated to department Y: $65,000 × (22/25) = $57,200

Important points to remember

Consider the following important points regarding the above example of cost allocation under step method:

1. You can see two steps of cost allocation. In first step, the cost of department A has been allocated to other service department (department B) as well
as to operating departments (department X and Y). The allocation base of department A has been ignored.
The amount of allocation base of a service department whose cost is being allocated to other departments is always ignored under both step and direct
method of cost allocation.
2. In second step, the total cost of department B ($45,000 + $20,000 = $65,000) has been allocated to department X and Y. No portion of department B’s
cost has been allocated to department A.
Any amount of allocation base of a service department whose cost has already been allocated to other departments is ignored under step method of
cost allocation.

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Example 2
The Michigan Company provides the following selected data about its three service and two operating departments:

The order and bases for allocating service department costs is given below:

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11/2/2019 Step down method of cost allocation - explanation, example, advantages and disadvantages | Accounting for Management

1. Department A; allocation base is “number of employees”.

2. Department B; allocation base is “space occupied”.
3. Department C; allocation base is “hours of time”.

Required: Allocate the cost of service departments to operating departments using step down method of cost allocation.

Solution

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ONE COMMENT ON
Step down method of cost allocation

BRENDA PIUS

Thank you, this information has been very helpful.

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The difference in cost of two alternatives is known as what?

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