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What is the Step Allocation Method?

Step Allocation Method

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Step Allocation Method

The step allocation method, often used in managerial accounting and cost accounting, refers to a method for allocating service department costs to production departments in a sequential manner. Service departments, or support departments, are those departments that do not directly engage in production activities but provide services to other departments. Common examples include maintenance, human resources, and IT support.

In the step allocation method, the costs of one service department are allocated to all other departments (both production and service departments) based on a predetermined allocation base, like machine hours or square footage. Once the costs of the first service department are fully allocated, you move on to the next service department and repeat the process. It’s crucial to note that once a service department’s costs are allocated, no costs are allocated back to it from other service departments.

The steps to use the step allocation method are:

  1. Rank Service Departments: Decide the order in which service departments will have their costs allocated. This ranking can be based on the proportion of each service department’s services used by other service departments.
  2. Allocate Costs: Begin with the first service department in the ranking. Allocate its costs to all other departments (both production and service) based on a predetermined allocation base (e.g., the number of employees, square footage, machine hours, etc.).
  3. Move to the Next Department: After the costs of the first service department are allocated, move on to the next service department. Allocate its costs to all other departments except for the service department(s) you’ve already allocated.
  4. Repeat Until All Service Departments Are Allocated: Continue the process until the costs of all service departments are allocated.

Example of the Step Allocation Method

Let’s explore a detailed example of the step allocation method using hypothetical figures for a manufacturing company.

Scenario:

Imagine a manufacturing company with two production departments: Production A (ProdA) and Production B (ProdB). The company also has two service departments: Human Resources (HR) and Maintenance (Maint).

Based on an analysis, the company determines that the Maintenance department provides more services to other departments than HR does. So, Maintenance costs will be allocated first.

Given Costs:

  • HR: $120,000
  • Maintenance (Maint): $150,000

Allocation Basis:

  • HR costs will be allocated based on the number of employees.
  • Maint costs will be allocated based on machine hours.

Allocation Breakdown:

For HR:

  • ProdA: 50 employees
  • ProdB: 30 employees
  • Maint: 20 employees

Total Employees = 100

For Maintenance:

  • ProdA: 600 machine hours
  • ProdB: 300 machine hours
  • HR: 100 machine hours

Total Machine Hours = 1,000

Step Allocation:

  1. Allocate Maintenance Costs:

Using machine hours:

  • ProdA gets 600 / 1,000 x $150,000 = $90,000
  • ProdB gets 300 / 1,000 x $150,000 = $45,000
  • HR gets 100 / 1,000 x $150,000 = $15,000

Now, the total cost for HR becomes $120,000 (original) + $15,000 (from Maint) = $135,000.

  1. Allocate HR Costs:

Using the number of employees:

  • ProdA gets 50 / 100 x $135,000 = $67,500
  • ProdB gets 30 / 100 x $135,000 = $40,500

(Notice we don’t allocate back to Maintenance since it was already the first service department whose costs were allocated.)

Final Allocations:

To the Production Departments:

  • ProdA: $90,000 (from Maint) + $67,500 (from HR) = $157,500
  • ProdB: $45,000 (from Maint) + $40,500 (from HR) = $85,500

In this example, the step allocation method provided a systematic way to allocate the costs of service departments to the production departments based on their usage and interdepartmental relationships. The decision to allocate Maintenance first was based on its broader service provision across the other departments.

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