Page 962 - Accounting Principles (A Business Perspective)

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be ignored in the cost allocation process. Because these services are not allocated to other service departments,
some accountants believe the direct method is not accurate.
The second method of allocating service department costs is the step method. This method allocates service

costs to the operating departments and other service departments in a sequential process. The sequence of
allocation generally starts with the service department that has incurred the greatest costs. After this department's
costs have been allocated, the service department with the next highest costs has its costs allocated, and so forth
until the service department with the lowest costs has had its costs allocated. Costs are not allocated back to a
department that has already had all of its costs allocated.
To illustrate the direct method and the step method, we use the following data:
Service Department Operating Departments
Maintenance Administration 1 2
Costs $ 8,000 $ 4,000 $ 32,000 $ 36,000
Machine-hours used 1,000 2,000 1,500 2,500
Number of employees 100 200 250 150
The costs of the maintenance department are allocated based on the machine-hours used. For the
administration department, the cost allocation is based on the number of employees.
Using the preceding data, an example of the direct method follows:

Service Departments Operating Departments
Maintenance Administration 1 2
Costs $ 8,000 $ 4,000 $ 32,000 $ 36,000
Allocation of (8,000) 3,000 5,000
maintenance
department's costs*
$ -0-
Allocation of (4,000) 2,500 1,500
administration
department's costs†
$ -0- $ 37,500 $ 42,500
* Department 1's fraction is 1,500/4,000; Department 2's fraction is
2,500/4,000.
† Department 1's fraction is 250/400; Department 2's fraction is
150/400.

Using the same data, an example of the step method follows:
Service Departments Operating Departments
Maintenance Administration 1 2
Costs $ 8,000 $ 4,000 $ 32,000 $ 36,000
Allocation of (8,000) 2,667 2,000 3,333
maintenance
department's costs*
$ -0-
Allocation of (6,667) 4,167 2,500
administration
department's costs†
$ -0- $ 38,167 $ 41,833
* Administration 1's fraction is 2,000/6,000; Department 1's fraction:
1,500/6,000; Department 2's fraction: 2,500/6,000.
† Department 1's fraction: 250/400; Department 2's fraction is
150/400.

Accounting Principles: A Business Perspective 963 A Global Text