# Step Method of Cost Allocation:

## Definition:

Step method is the method of allocating service department’s costs to other service departments, as well as to operating departments, in a sequential manner. The sequence typically starts with the service department that provides the greatest amount of service to other departments.

## Explanation:

Unlike the direct method, the step method provides for allocation of a service department’s costs to other service departments, as well as to operating departments. The step method is sequential. The sequence typically begins with to department that provides the greatest amount of service to other service departments. After its costs have been allocated, the process continues, step by step, ending with the department that provides the least amount of services to other service departments.

## Example:

### To provide an example of the step method, consider Mountain View Hospital, which has two service departments and two operating departments as shown below:

 Description Service Department Operating Department Total Hospital Administration Custodial Services Laboratory Daily Patient Care Departmental costs before allocation Employee hours Space occupied square feet \$360,000 12,000 10,000 \$90,000 6,000 200 \$261,000 18,000 5000 \$689,000 30,000 45,000 \$1,400,000 66,000 60,200

### Hospital administration costs will be allocated on the basis of employee-hours and Custodial Services costs will be allocated on the basis of square feet occupied.

The step method of allocating the hospital’s service department costs to the operating departments is shown below:

 Description Service Department Operating Department Total Hospital Administration Custodial Services Laboratory Daily Patient Care Departmental costs before allocationAllocation: Hospital administration costs (6/54, 18/54, 30/54)* Custodial service department costs (5/50, 45/50)** Total costs allocation \$360,000  (360,000) ———– \$0 ====== \$90,000  40,000 (130,000) ———- \$0 ===== \$261,000  120,000 13,000 ———– \$394,000 ====== \$689,000  200,000 117,000 ———- \$1,006,000 ======= \$1,400,000    1,400,000 =======

*Based on the employee-hours in custodial services the two operating departments, which are 6,000 hours + 18,000 hours + 30,00 hours = 54,000 hours
**Based on the space occupied by the two operating departments, which is 5,000 square feet + 45,000 square feet = 50,000 square feet

Example shows the treatment of step method of cost allocation. Note the following three key points about these allocations.

1. First, under the allocation heading in the solution you see two allocations, or steps. In the first step, the costs of hospital administration are allocated to another service department (Custodial Services) as well as to the operating departments. In contrast to the direct method, the allocation base for Hospital Administration costs now includes the employee hours for custodial services as well as for the operating departments. However, the allocation base still excludes the employee-hours for Hospital Administration itself. In both the direct and step methods, any amount of the allocation base attributable to the service department whose cost is being allocated is always ignored.
2. Second, looking again on the example, note that in the second step under the allocation heading, the cost of custodial services is allocated to the two operating departments, and non of the cost is allocated to Hospital Administration even though Hospital Administration occupies space in the building. In the step method, any amount of the allocation base that is attributable to a service department whose cost has already been allocated is ignored. After a service department’s cost have been allocated, costs of other service departments are not reallocated back to it.
3. Third, not that the cost of Custodial Services allocated to other departments in the second step (\$130,000) in example, includes the costs of Hospital Administration that were allocated to Custodial Services in the first step.