Reciprocal services refer to the mutual exchange of services between two or more departments or units within an organization. In the context of cost accounting and allocation, it’s commonly used to describe the scenario where service (or support) departments provide services not only to production departments but also to other service departments.
The significance of recognizing reciprocal services:
- Accuracy in Cost Allocation: In many organizations, service departments provide essential functions to each other. For example, an IT department might support an HR system, while the HR department provides recruitment and training services for the IT department. If these mutual services are not considered, the cost allocation may not accurately reflect the real consumption of services.
- Complexity in Allocation: Recognizing reciprocal services adds complexity to the cost allocation process. While methods like the direct and step-down (or sequential) methods ignore or simplify the mutual service flows, the reciprocal method attempts to allocate costs by accounting for these mutual services.
- Decision Making: Understanding the true cost of running a department, including the costs of reciprocal services, can help management make informed decisions about budgeting, outsourcing, or streamlining operations.
Example of Reciprocal Services
Let’s use a simple hypothetical scenario to illustrate reciprocal services.
Imagine a hospital with two service departments: the IT (Information Technology) Department and the Administrative Services Department. Both departments provide services to each other and to the primary patient care department.
- The IT Department manages software and hardware issues for the entire hospital, including computer systems used in the Administrative Services Department.
- The Administrative Services Department handles payroll, hiring, and other administrative tasks, including these services for the IT Department employees.
Reciprocal Services Breakdown:
- IT Services to Administrative Services:
- Server maintenance for the Administrative Department’s database.
- Tech support for software issues related to payroll and HR systems.
- Administrative Services to IT:
- Handling IT employee payroll.
- Recruitment and onboarding processes for new IT staff.
- Providing office supplies for the IT Department.
Cost Allocation Scenario:
Suppose the direct annual costs incurred by the IT Department are $200,000 and by the Administrative Services Department are $150,000.
Based on data gathered:
- 20% of IT’s services are used by the Administrative Services Department.
- 15% of Administrative Services’ workload relates to IT Department needs.
To account for these reciprocal services, when allocating costs:
- IT Department’s reciprocal services cost for Administrative Services = 20% of $200,000 = $40,000.
- Administrative Services’ reciprocal services cost for IT = 15% of $150,000 = $22,500.
Now, if the hospital wanted to allocate these costs back to each department, it would add these reciprocal costs to the direct costs:
- Total costs for IT Department: $200,000 + $22,500 = $222,500.
- Total costs for Administrative Services: $150,000 + $40,000 = $190,000.
This adjusted cost structure reflects the mutual services exchanged between the two departments.
This example highlights the concept of reciprocal services. In a real-world scenario with multiple departments providing services to each other, the calculations might become more complex, necessitating the use of the reciprocal method for a more accurate allocation.