Department of Business Management

Course Title – Cost and Management Accounting 1

Course Code – AcFn 3041
Program – Degree Extention
International Marketing Individual Assignment 1
Assignment Title – Departmental Service Cost Allocation

Section – 4DEB1
Prepared By
Name Id no
1. Kalkidan Teshome 2618/19

Submitted to - Getahun Guta

Submission Date – 18/04/2015

1
Definition of Departmental Service Cost Allocation
Is the process of identifying, accumulating, and assigning costs to costs objects such as
departments, products, programs, or a branch of company. Is refers to a process of accounting
and recording the full costs of a government service by including its indirect costs or “overhead”
in addition to its direct costs.

Methods of Departmental service cost allocation

There are three methods for allocating service department costs

①. Direct Method

②. Sequential Methodand

③. Reciprocal Method

1. Direct Method: This method allocates costs to the operating departments directly, with no
allocations to the other service departments. The method is easy to impliment , but it ignores the
fact that over service departments require services from each other, so it's less accurate.

The direct method was used most in practice until the 1970s, when the Cost Accounting
Standards Board (CASB) established a standard for service department cost allocation.

2. Sequential Method: Is known as step-down method, allocates costs to operating

departments and other service departments sequentially, but only in one direction. This method
partially recognizes other service departments, which makes it more accurate than the direct
method.

3. Reciprocal Method: Is fully recognizes the other service departments by allowing

reallocations back to each service department. As such, it's more difficult to calculate but also
more accurate than the other method.

Purpose of Departmental service cost allocation

There are four main purposes for allocating costs are

 To predict the economic effects of planning and control decisions

 To motivate managers and employees
 To measure the costs of inventory and costs of goods sold
 To justify costs for pricing or reimbursement.

2
Advantage and disadvantages of departmental service cost alloccation

Advantage
Allocation based on department need: By plitting funds between different departments
or teams, a small business can provide funding based on the needs of the division and shift the
allocation over time as conditions change.

Companywide and department allocation: A small buiseness can use multiple cost
allocations to separate funds for the entire company from funds meant for individual
departments. This is useful when budgeting overhead costs and simillar companywide costs or
strategies.

In-depth cost management: As the budget is apportioned to each department, companies

can get a clearer look at which activities are the most cost efficient.

Better department strategy: When funds are allocated to individual departments,

departments know their budgets well ahead of time.

Disadvantage
Variable costs pose challenges: Each department tends to have different variable costs,
and accurately tracking or predicting these variable costs can be challenging, especially in the
beginning.

Actual usage can go under budget: The opposite problemcan also happen if a business
misjudges costs and allocates a department a larger budget than it needs, the department may not
use its funds correctly.

Department favoritism can be a factor: Allocating can sometimes lead to favoritism,

where one department recives much more than the others if cost managers care for it more.

Budget percentages may be misleading: As cost allocation shifts, snapshot looks at the
overall company budget can become mislesding.