Selecting Allocation Base

Selecting Allocation Base:

Costs are ordinarily assigned to products and services by using a two stage process. In first stage, service department and other costs are allocated to operating departments. In second stage, the costs that have been assigned to operating departments are allocated to products and services. Here we will focus on the first stage, in which service department costs are allocated to operating departments.

In the first stage, service department costs are allocated to operating departments by using a unique allocation base for each service department. The allocation base that is used to allocate a particular service department’s costs should “drive” those costs. For example, the number of meals served would commonly be used as the allocation base for cafeteria costs because the costs incurred in the cafeteria are driven to a large extent by the number of meals served. Ideally the total cost incurred in the service department should be directly proportional to the allocation base. If the allocation base increases or decreases by 10%, the service department cost should increase or decrease by 10% as well. Managers also often argue that an allocation base should reflect as accurately as possible the benefits that the various departments receive from the service department.

For example the most managers would argue that square feet building space occupied by each department should be used as the allocation base for janitorial services because both the benefits and costs of janitorial services tend to be proportional to the amount of space occupied by a department. A given service department’s cost may be allocated using more than allocation base (see examples below). For example, data processing costs may be allocated on the basis of CPU minutes for mainframe computers and on the basis of number of personal computers used in each operating department.

In addition to explanation of how to select an allocation base, another critical factor should not be overlooked. The allocation base should be clear and straightforward and easily understood by the managers to whom the costs are being allocated.

Examples of Bases, Company Used to Allocate Service Department Costs

Service DepartmentLandry
Airport ground services
Medical facilities
Materials handling
Data processing

Custodial services (building and ground)
Cost accounting
Human resources

Receiving, shipping, and stores
Factory administration

Bases (Cost drivers) InvolvedPonds of Landry
Number of flights
Number of meals
Cases handled; number of employees; hours worked
Hours of service; volume handled
CPU minutes; lines printed; disk storage used; number of personal computers.
Square footage occupied.
Labor hours; clients or patients serviced
KWH used; capacity of machines
Number of employees; employee turnover; training hours.
Units handled; number of requisitions; space occupied
Total labor hours
Machine hours

You may also be interested interested in other articles from “service department costing” chapter:

  1. Selecting Allocation Bases
  2. Direct Method of Cost Allocation in Service department costing
  3. Step Method of Cost Allocation in Service Department Costing
  4. Reciprocal Method of Cost Allocation-Service Department Costing

Other Related Accounting Articles:

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