What is Stage 1 Allocation?

Stage 1 Allocation

Stage 1 Allocation, also known as first-stage allocation, refers to the initial process of allocating the costs of support departments (or service departments) to operating departments (or production departments) in a cost accounting system. The primary goal is to distribute the overhead costs of support departments to those departments that actually use the services.

This process is essential because support departments, although they do not directly contribute to production, provide essential services that benefit the operating departments. Therefore, it’s necessary to distribute their costs to get a more accurate understanding of total production costs.

The allocation can be done based on various criteria, such as:

• Direct Method: This is the simplest method. Support department costs are directly allocated to the operating departments based on a chosen allocation base (like machine hours or labor hours), without considering the services support departments provide to each other.
• Step-down Method (or Sequential Method): With this method, the costs of one support department are allocated to all other departments, including other support departments. Once a support department’s costs are allocated, no costs are allocated back to it. The order in which departments allocate their costs to others can be based on which department provides the most service to others or other criteria.
• Reciprocal Method: This method recognizes that support departments provide services to each other. It involves a set of simultaneous equations to allocate costs, taking into account the mutual services provided by support departments to one another.

Example of Stage 1 Allocation

Let’s delve into an example to illustrate the concept of Stage 1 Allocation in a manufacturing setting.

Scenario: Wonder Widgets Inc. manufactures two main types of widgets: Classic and Modern. They have two production departments: Production A (for Classic) and Production B (for Modern). Additionally, they have two support departments: Maintenance and Administration.

Annual Costs:

• Maintenance: $200,000
• Administration: $150,000

Wonder Widgets decides to allocate Maintenance costs based on the number of machine hours used by each department, and Administration costs based on the square footage occupied by each department.

Machine Hours Used:

• Production A (Classic): 4,000 hours
• Production B (Modern): 6,000 hours
• Total: 10,000 hours

Square Footage Occupied:

• Production A (Classic): 1,500 sq.ft.
• Production B (Modern): 2,500 sq.ft.
• Total: 4,000 sq.ft.

Stage 1 Allocation Using Direct Method:

• Maintenance Costs Allocation:
  • Based on Machine Hours
  Production A (Classic):
  = (4,000 hours / 10,000 hours) × $200,000
  = $80,000
  Production B (Modern):
  = (6,000 hours / 10,000 hours) × $200,000
  = $120,000
• Administration Costs Allocation:
  • Based on Square Footage
  Production A (Classic):
  = (1,500 sq.ft. / 4,000 sq.ft.) × $150,000
  = $56,250
  Production B (Modern):
  = (2,500 sq.ft. / 4,000 sq.ft.) × $150,000
  = $93,750

Total Allocated Costs:

• Production A (Classic): $80,000 (Maintenance) + $56,250 (Administration) = $136,250
• Production B (Modern): $120,000 (Maintenance) + $93,750 (Administration) = $213,750

In this example, the support department costs (Maintenance and Administration) are directly allocated to the production departments based on relevant allocation bases (machine hours and square footage). After the Stage 1 Allocation, Production A and Production B have a clearer picture of their total departmental costs, which includes the support costs associated with their production activities.