Question

At the beginning of this year, a group of lawyers and accountants in Calgary decided to join efforts in providing one-stop legal and accounting consulting services to industry and the government. The group established a consulting company, rented office space, and hired both professional and clerical staff.

      Following several initial organizational meetings, the partners decided to divide the operation into three parts: the Consulting Department, the Legal Department, and the Accounting Department.

     The consulting department deals directly with the clients, providing two somewhat distinct services, accounting consulting (AC) and legal consulting (LC). In its first full month of operations, this department recorded its own identifiable costs as $20,000, with 30% attributed to accounting consultations and 70% to legal work. Billings to clients amounted to $40,000 and $25,500 for accounting and legal consultations, respectively. This department made use of the other two departments’ services in preparing work for the external clients.

     The accounting and legal departments provided professional services for each other and for the consulting department on the basis of time according to the following schedule:

							Consulting
	Accounting Department			Legal Department			AC			LC
Departmental costs before allocation	$	10,000		$	15,000			?			?
Proportion of Accounting Department services used					20	%		60	%		20	%
Proportion of Legal Department services used		50	%					10	%		40	%

The accounting department incurred $10,000 in costs in the first month, and the legal department incurred $15,000. Neither department directly bills external clients.

     Having completed the first month’s activity, the partners are ready to evaluate the performance of the group and of the individual areas.

Required:
1.Prepare an income statement for each consulting branch using the direct allocation method.

2. Prepare an income statement for each consulting branch using the the step-down method.

3. Recommend one of the two methods to the partners and justify your choice.

• Direct allocation method

• Step-down method

• Direct allocation method

• Step-down method

Answer 1

Please find below table useful to compute desired results: -

End results would be as follows: -

3. Step-down Method because cost allocation is more practical and reliable in case of Step down method and shows accurate net Income.