INTEGRATED ACCOUNTING REVIEW CLASS IN ADVANCED FINANCIAL ACCOUNTING AND REPORTING (AFAR)

AFAR 18 – Service Department Cost Allocation

NATURE OF A SERVICE DEPARTMENT

A service (or support) department is a unit in an organization that contributes in an indirect way to the conversion of
materials into a finished product. It contributes a service that enables the organization’s production process to taka
place. Examples of service department are:
1. Personnel department
2. Warehousing
3. Maintenance department

Since these departments support the production department, the costs incurred by these departments must be
allocated to production departments to determine the full cost of a product.

METHODS OF ALLOCATING SERVICE DEPARTMENT COSTS

Service departments can be allocated to production departments using one of the following methods:

1) Direct method – assigns support department costs only to producing departments.

- the simplest allocation method.
- No consideration is given to service performed by one service department for another service
department.

2) Step method – allows a partial recognition of the effects of interaction among support departments.
- No cost is assigned to service departments whose costs have already been allocated.

Benefits-provided ranking – begins with the support department providing the most service to all other support
areas and ends with the support department providing the least service to all other support areas.
o Those of the service department that provides the highest percentage of its total services to other service
departments.
o Another is to begin with the costs of the service department providing services to the greatest number of
other service departments.
o Another is to begin with the service department having the greatest peso cost of services provided to other
service departments.

3) Algebraic method – considers all departmental interrelationships and reflects these relationships in
simultaneous equations.
- the most complex of all the allocation techniques but it is the most theoretically correct and
provides the most accurate and reliable allocations.

DISCUSSION PROBLEM
McDowells Company is exploring ways to allocate the cost of its service departments namely, Quality Control and
Maintenance to the company’s production departments namely, Machining and Assembly. The controller of the company
has provided the following information:

Quality Control Maintenance Machining Assembly TOTAL

Budgeted overhead costs
before allocation P350,000 P200,000 P400,000 P300,000 P1,250,000
Budgeted machine hours - - 50,000 hours - 50,000 hours
Budgeted direct labor hours - - - 25,000 hours 25,000 hours
Budgeted hours of service of
quality control - 7,000 hours 21,000 hours 7,000 hours 35,000 hours
Budgeted hours of service of
maintenance 10,000 hours - 18,000 hours 12,000 hours 40,000 hours

1. Under the direct method of allocating service department costs, what are the total service costs allocated
to the machining and assembly departments, respectively?
2. Under the step-down method of allocating service department costs from quality control to maintenance,
what are the total service costs allocated to the machining and assembly departments, respectively?
3. Under the algebraic/reciprocal method of allocating service department costs, what are the total amount of
quality control costs and total amount of maintenance costs, respectively, to be allocated to the other
departments?
4. Under the algebraic/reciprocal method of allocating service department costs, what are the total service
costs allocated to the machining and assembly departments, respectively?

---END---

BRIAN CHRISTIAN S. VILLALUZ, CPA, MBA

CPA Reviewer, Advanced Review Solutions
YouTube Content Creator, Accounting Lessons with BCV
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BRIAN CHRISTIAN S. VILLALUZ, CPA, MBA

CPA Reviewer, Advanced Review Solutions
YouTube Content Creator, Accounting Lessons with BCV
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