The direct method makes no cost allocations between or among service departments.
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Direct MethodThe direct method transfers the cost of a service department directly to the productive departments that rely on the services. The allocation is usually based upon some logical benchmark. For example, janitorial services may be allocated to productive departments based on square footage used by the productive departments. Cafeteria costs may be allocated based on the number of employees within each production department. The base selected should bear a logical relationship to the consumption of services and their costs. Assume that Benjamin Printing has two production departments: printing and binding. Printing is highly automated. Binding relies on a far more labor-intensive process. These departments are supported by maintenance and cafeteria service units. Maintenance activities are driven by the amount of machinery requiring service and repair. Cafeteria services is directly related to the size of the labor pool. As shown, costs incurred by the Maintenance Department are allocated based on number of machines used by each productive department. Cafeteria costs are allocated based on number of employees. Step MethodSome service departments may provide support to other service departments. For instance, Benjamin’s maintenance employees likely eat in the cafeteria. This issue is mitigated by a step method of allocation. A service department’s cost is first allocated to other units, including other service departments. Then, the “resulting costs” of the other service departments are allocated to production. This step allocation is demonstrated for Benjamin, assuming that cafeteria costs benefit maintenance, printing, and binding:
Principlesofaccounting.com ™ Copyright © 2022. All rights reserved. What is the Direct Allocation Method?The direct allocation method is a technique for charging the cost of service departments to other parts of a business. This concept is used to fully load operating departments with those overhead costs for which they are responsible. For example, the janitorial staff provides services to clean all company facilities, while the maintenance department is responsible for company equipment, and the IT department maintains the information technology systems. These are all service departments. How to Account for the Cost of Service DepartmentsThere are three ways to account for the cost of these service departments, which are noted below. In general, the indirect allocation method requires an excessive amount of accounting work, and so is not recommended. However, the direct allocation method represents a reasonable mix of modest additional clerical work and a more accurate cost allocation. Direct Charge Off MethodSimply charge the cost of these departments to expense as incurred. This is the simplest and most efficient method, but it does not reveal how costs are incurred, and tends to accelerate expense recognition. Direct Allocation MethodCharge the applicable cost of these departments directly to the production part of the business. These costs form a portion of the overhead cost of production, which is then allocated to inventory and the cost of goods sold. This method provides a better picture of how costs are incurred, but requires more accounting effort. It also tends to delay the recognition of expenses until a later period, when some portion of the produced goods are sold. Indirect (or Interdepartmental) Allocation MethodFirst charge the applicable cost of the service departments to the other service centers, and then allocate costs to the production part of the business. This approach is more complicated, but results in the most fine-tuned cost allocation, based on cost usage patterns. The method is only useful if management intends to take action based on the outcome of the analysis. What is the direct method of cost allocation?The direct allocation method is a technique for charging the cost of service departments to other parts of a business. This concept is used to fully load operating departments with those overhead costs for which they are responsible.
How service costs are allocated to producing departments using direct method?The direct method allocates costs to the operating departments directly, with no allocations to the other service departments. The method is easy to implement, but it ignores the fact that other service departments require services from each other, so it's less accurate.
Can direct costs be allocated?Because direct costs can be specifically traced to a product, direct costs do not need to be allocated to a product, department, or other cost objects. Direct costs usually benefit only one cost object. Items that are not direct costs are pooled and allocated based on cost drivers.
When would the direct method and the step down method of service department cost allocation result in identical allocations being made to the operating departments?When would the direct method and the step-down method of service department cost allocation result in identical allocations being made to the operating departments? A. That can happen only if there's an equal amount of service departments and operating departments.
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