Some departments within a company only exist to serve other departments. When allocating the costs incurred at these departments, companies must consider various factors. A technique that can help achieve that is the step allocation method.
What is the Step Allocation Method?
The step allocation method, or the step-down method, is a cost allocation technique that distributes service department sequentially costs to production departments. This method ranks service departments based on service provided to other departments and allocates their costs accordingly.
Unlike the direct method, which only allocates service department costs to production departments, the step method allows for partial allocation to other service departments. This process continues until all service department costs have been distributed to the production departments, reflecting a more accurate picture of interdepartmental services.
How does the Step Allocation Method work?
The step allocation method allocates service department costs to production departments in a hierarchical and sequential order. First, service departments are ranked based on the amount of service they provide to others. The highest-ranked service department’s costs are then allocated to all other departments, including both service and production departments, using an appropriate allocation base.
Next, the method moves to the next ranked service department, allocating its total costs, which include costs received from the previously allocated department. This sequence continues until all service department costs are fully allocated to the production departments. By considering interdepartmental services, the step allocation method provides a more accurate distribution of costs, leading to better cost control and informed decision-making within the organization.
What are the advantages of the Step Allocation Method?
The step allocation method offers enhanced accuracy in cost allocation by recognizing the interdepartmental services provided among service departments. This sequential approach, starting with the department that provides the most services, ensures costs are allocated more precisely based on actual usage. This method’s attention to detail allows organizations to reflect the true costs incurred by each department better, leading to more accurate financial reporting and insights.
Additionally, the step allocation method supports better decision-making and cost control. By providing a clearer understanding of cost structures, managers can identify inefficiencies and areas for potential savings. The fair and equitable distribution of costs also ensures that each department bears a realistic share of expenses, fostering a more accurate reflection of organizational dynamics and supporting more informed budgeting and performance evaluations.
What are the disadvantages of the Step Allocation Method?
The step allocation method’s complexity and detailed data requirements make it a time-consuming process. Gathering and maintaining extensive data on interdepartmental services is labour-intensive, and the sequential allocation process can be challenging to implement compared to other methods. Additionally, the method introduces potential biases, as ranking service departments and selecting allocation bases can involve subjective decisions.
Moreover, the method has limitations in handling reciprocal services, as once a service department’s costs are allocated, it does not receive further allocations from other departments. This one-way allocation can reduce the accuracy in situations with significant interdepartmental services. Implementing the step allocation method also requires specialized knowledge and advanced accounting systems, which can be a barrier for organizations lacking the necessary expertise and resources.
Conclusion
The step allocation method allows companies to distribute costs for service departments to production departments. This method establishes rankings for each service and allocates its costs sequentially. Thereby, it helps companies include the expenses incurred in service departments as a part of their decision-making. However, it may have some disadvantages as well.
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