SERVICE DEPARTMENTS COSTS OF A WOOD PROCESSING FIRM IN BUTUAN CITY: DETERMINATION OF A MOST EQUITABLE MODEL FOR DISTRIBUTION

Abstract In a business, departments are categorized as production or operating departments, and service or support departments. A production department is one whose efforts are directed toward adding value to a product or service sold to a customer. Such departments are the ones that directly generate the revenue of a business. Behind the operating departments are the service departments whose services are mainly to give support to the production. Proper costing practices necessitate the absorption by the production departments of the costs of the service departments up to the extent of benefits they obtain from services rendered of the latter. This is in accordance to the cost-benefit principle where benefits derived should be attributed to the related costs incurred. It is therefore integral for a highly realistic evaluation of performance of a department, to have a proper and equitable service cost allocation method. This study is hence

conducted to determine the method of service department cost allocation that would be most appropriate to the nature of the business of the wood processing company. The first aim of this research is to assess the current service department cost allocation method of the wood processing company, including the various variables relevant to the study. The second aim is to compare the results of the aforementioned to

those of the various other possible methods of allocation, namely, Direct Method, StepDown, and Reciprocal Method, if they are applicable, and determine which would yield the most appropriate performance evaluation in terms of Profit Margin and Cost Ratio. Finally, this study expects to be able to determine the most appropriate cost allocation model by combining the characteristics of the methods that are to be found appropriate in the wood processing firm. The service departments of the company are Maintenance, Logyard, Security, Accounting, and Marketing. The production departments are CCA-C Treatment, Creosoting, and Saw Milling. Out of the full costs generated from the different methods, ratios are computed: first to show the evaluation of performance of each production department under each method; and second, to be the bases for comparing the methods in order to determine the most ideal one. the study relates back to the theoretical concept referring to the Reciprocal method as the most theoretically sound of the three methods and that the direct and step down methods for making support department allocations are really special cases of the more general reciprocal method. This being said, the reciprocal method is to serve as base for comparison of ratios between methods. Findings show that under the companys current method, it seemed that the Saw Milling Departments is operating well compared to the other departments in terms of gross profit ratios. With the direct method, it is noticeable that the operating department that performs well is the CCA-C Treating Department, while the other two departments gross profit ratio decreased compared to the first method. Under step-down, the result is quite similar to the result of the method currently used by the company. And it is

noticeable that in this case the Saw Milling Department performs well compared to the others. The results of Reciprocal method imply that the Saw Milling Department provides the company with a much better operating performance than the other two. Although the variances of the performance between the current method used by the company compared to the reciprocal method are not that significant specifically in the CCA-C Treating Department and Creosoting Department. Based on the preceding analysis of the results of performance evaluation of the operating departments of the company, the Saw Milling Department has the highest standard of performance with an average gross profit rate of 27.37% using the four costs allocation method, followed by the CCA-C Treating Department with an average gross profit of 25% and lastly the Creosoting Department with an average gross profit rate of 21.91%. From the analysis of the process and results of the Direct Method it can be inferred that it fails to consider that a service department does not only render its service to the operating departments but also to its fellow service department. And the actual allocated service department costs are quite material to the real costs that should be allocated. And by using the Step-Down Method, since it considers interdepartmental cost allocation, the effect of having inaccurate allocated costs will be minimized. It is said to be minimized only because it fails to consider the full inter-service departmental costs allocation. So in this method the first service department and the next once its own costs is fully charged to other departments (both service and operating) will not have its share to the costs of other service departments through it benefits from such

costs. Thereby the objective of having the most appropriate performance evaluation system using this method is not reached. But if we are to weigh more on the most accurate way of charging the service department costs to every operating department the Reciprocal Method would yield the best result because of its very nature of considering the full inter-service departmental costs allocation. Though it is quite complex to solve in order to come up with the correct service department costs to be charged to the operating departments, however it will be beneficial to the company's management because it will provide them with the most fair and accurate performance evaluation system. And by using this kind of cost allocation method the company's management can effectively determine which operating department performed well and which one need more improvement so as to balance the standard of performance in every operating department and also in order to attain unity and goal-congruence, thereby allowing each person responsible in every operating department to attain the best standard of performance. In conclusion, the service department cost allocation method most suitable to the company is the reciprocal method. Its mathematical approach provides more accurate distribution of the service department costs to the operating units. Under this method, the total cost of each producing unit does not deviate much from what is currently charged to it at present. Moreover, the reciprocal method shows that the producing department that has incurred the highest cost also gets the highest cost allocation as compared to the step down or the direct method.