The second method of allocating service department costs is the step method. This method allocates service costs to the operating departments and other service departments in a sequential process. The sequence of allocation generally starts with the service department that has incurred the greatest costs. After this department’s costs have been allocated, the service department with the next highest costs has its costs allocated, and so forth until the service department with the lowest costs has had its costs allocated. Costs are not allocated back to a department that has already had all of its costs allocated.
For this example, we will use the same data as before which was:
| Service Dept | Operating Dept | |||
| Maintenance | Administration | 1 | 2 | |
| Costs | $8,000 | $4,000 | $32,000 | $36,000 |
| Machine-hours used | 1,000 | 2,000 | 1,500 | 2,500 |
| Number of Employees | 100 | 200 | 250 | 150 |
In the step method, we typically begin with the highest service cost first. We will start with Maintenance and allocate the cost to all remaining operating AND service departments (administration, operating dept 1 and operating dept 2). When calculating the allocation rate, we never use the service department cost driver itself (so do not use the maintenance machine hours used).
| Maintenance Cost | = $8,000 | =$8,000 | = $1.3333 per machine hour |
| Machine Hours (all but maintenance) | (2,000 + 1,500 + 2,500) | 6,000 |
We would allocate maintenance to Administration, Operating Departments 1 and 2 using the machine hours for each department x the maintenance rate per machine hour (round final answer to nearest dollar).
| Admin | Oper. Dept 1 | Oper. Dept 2 | |
| Maintenance | 2,667 | 2,000 | 3,333 |
| (2,000 MH x 1.333) | (1,500 MH x 1.3333) | (2,500 MH x 1.3333) |
Next, we would allocate the administration department. The total administration cost has changed since we have the original department costs of $4,000 + maintenance cost allocated above of $2,667 making the new administration cost $6,667. Administration will be allocated based on number of employees. We will use the operating departments only since we have already allocate all of maintenance costs and there are no other service departments.
| Administration Cost | = $6,667 | =$6,667 | = $16.6675 per employee | |
| Employees (operating depts only) | (250 + 150) | 400 | ||
We would allocate administration to the operating departments only by taking each department number of employees x the administration rate per employee (round final answer to nearest dollar).
| Oper. Dept 1 | Oper. Dept 2 | |
| Administration | 4,167 | 2,500 |
| (250 employees x 16.6675) | (150 employees x 16.6675) |
The final cost allocation would appear as follows:
| Service Dept | Operating Dept | |||
| Maintenance | Administration | 1 | 2 | |
| Costs | $8,000 | $4,000 | $32,000 | $36,000 |
| Maintenance cost allocated | ($8,000) | 2,667 | 2,000 | 3,333 |
| Administration cost allocated | ($6,667) | 4,167 | 2,500 | |
| Total Costs | $0 | $0 | $38,167 | $41,833 |
Remember, the step method recognizes a one-way relationship between service departments and once the service department cost has been allocated out to other departments, we do not go back and give additional costs to that department.