In: Accounting
Describe how the direct, step-down and reciprocal cost allocation methods differ in the way they recognise reciprocal services among support departments.
Type to copy and paste
Three methods of allocating overheads from Service department to Production department
Direct method of overhead allocation is done without considering service rendered by one service department to another. It means cost is directly allocated to production department based on the ratio of services consumed.
Step method of overhead allocation allocates overhead in a sequence for all the departments. Usually service department which renders highest amount of service is allocated first and then next service department in a sequence. So the first service department cost allocated does not get share of cost from other service department
Reciprocal method of allocation considers the service rendered by service departments to each other. Hence it considers mutual allocation of overheads between service departments. It can solved through algebraic method or trial and error method. This is the only method which considers mutual allocation of cost between all service departments
Company might choose one method over the other if service rendered by department is significant and they want to give due consideration for the same in overhead allocation. If company does not want to allocate overheads between service department Direct method may be preferred else it may prefer Step method or Reciprocal method.