Question

3. Assume you are working for the organization and are requested to allocate support department costs. Describe how you would choose the best method?

Answer 1

Cost allocation is the process through which identification, aggregation and assigning costs is done to the cost objects. Cost object can be a department, a customer , a region , a project etc .Cost allocation is required to work out the financial cost , pertaining to a particular object as mentioned above and to spread the cost to the relevant objects or divisions.

The purpose of cost allocation is fair distribution of the costs to the respective department . On the basis of the cost working , the departmental managers are able to judge the performance of each department and take further actions to continue or control the costs as worked out , after allocation . They do it by comparison with other departments.

The task of allocating the support departmental cost is done with the help of any of the following , three methods :

1) Direct Method

2) Sequential Method

3) The Reciprocal method

Direct Method :

It is the simplest method out of the three allocation methods. It ignores the inter-departmental services among the departments and also the reciprocal transactions among the departments. All the cost of the service departments to the operating departments. It doesn’t include service to service department transactions, even it if is a material transaction.

Sequential Method:

Sequential method or the step by step method states that the costs of service departments are allocated to the Production as well as Service departments. Under this method , only partial transactions of services supplied by support departments are recognized. It is called step by step method as a service departments cost after allocating to other production as well as service departments, can have allocation of costs incurred by other service departments. This way costs of all service departments are allocated step by step.

The Reciprocal method :

Reciprocal method in fact recognizes the reciprocal services provided by support departments to the other support departments. It requires simultaneous equations. The Total cost of the support department is calculated in following way

Total cost of supporting department = Direct Cost + Allocated cost of support departments.

The Direct Method is the Simplest method.

The Reciprocal Method is somewhat complicated but it is the most accurate method as it considers the reciprocal cost of the support departments

Hence, as per our view, the Reciprocal Method is the best method for allocating Support Department Costs.