Question

• Describe the three (3) primary methods of cost allocation and describe how they differ.

Answer 1

The given are the primary methods of cost allocation (mainly in service department) and their differentiation.

a. The direct method

The direct method is the simplest and most common but considered as least precise of the methods. All service department costs do allocated directly to production departments. It disregards any service rendered by one service department to another, i.e., no attempt to allocate the costs of service departments to other service departments. Thus, in this method no allocation is done of the cost of services rendered to other service departments what makes it less appropriate method.

b. The step-down method

It is a sequential process. It is slightly more accurate than the direct method. Here, the service departments are allocated, but in order, from the one that provides the most service to other service departments down to the one that provides the least. As each allocation is performed, the costs of the services departments are allocated to both the remaining service departments and the production departments. This method allocates service department costs to other service departments in addition to the producing departments. That is, it allows for partial recognition of services rendered by service departments to another.

c. The reciprocal method

a. Theoretically, this method considered as most appropriate method for allocating department costs.

b. It allows reflection of all reciprocal services among service departments.

c. Simultaneous, calculations are used to compute the all-joint cost.