Step-down method

Definition

The step-down method is a systematic approach to allocating service department costs to production departments, which recognizes the interdependencies among service departments. This method involves allocating costs in a sequential manner, where one service department's costs are allocated to both production departments and other service departments based on predetermined allocation bases, before moving on to the next service department. This ensures that the costs are distributed more accurately than in simpler methods by considering the support provided by each service department to others.

5 Must Know Facts For Your Next Test

1. The step-down method allocates service department costs sequentially, starting with the highest total cost department and moving downwards.
2. It recognizes some degree of interdepartmental services by allowing certain service department costs to be allocated to other service departments before they are assigned to production departments.
3. This method is beneficial for organizations with multiple service departments that interact and provide support to one another, ensuring a fair distribution of costs.
4. The order in which departments are allocated can significantly impact the total cost assigned to production departments, so careful consideration is needed when determining the sequence.
5. While it is more accurate than simpler methods like the direct method, it is less complex than the reciprocal method, making it a preferred choice for many organizations.

Review Questions

• How does the step-down method improve upon the direct method of cost allocation?
  • The step-down method enhances the direct method by recognizing some interactions between service departments. Unlike the direct method, which allocates service costs solely to production departments without considering interdepartmental services, the step-down method first allocates costs from one service department to others before distributing them to production departments. This sequential allocation leads to a more accurate representation of the true costs incurred by production departments due to their reliance on various services.
• Discuss how the choice of allocation sequence in the step-down method can influence overall cost allocations.
  • The sequence in which departments are allocated in the step-down method can greatly affect the total costs assigned to production departments. For instance, if a high-cost service department is allocated first, its costs will influence the allocation base for subsequent allocations. This means that different sequences can yield different cost distributions among production departments, impacting decision-making related to pricing, budgeting, and performance evaluation.
• Evaluate the effectiveness of using the step-down method compared to the reciprocal method in an organization with interdependent service departments.
  • The step-down method strikes a balance between simplicity and accuracy when allocating costs in organizations with interdependent service departments. While it captures some degree of interaction between these departments by allowing for one-way cost allocations before reaching production departments, it does not account for all mutual services as thoroughly as the reciprocal method does. The reciprocal method provides a more comprehensive allocation by recognizing two-way interactions; however, its complexity can make implementation challenging. Thus, organizations must weigh their need for precision against the practicality of implementing each method based on their specific operational context.

Related terms

Direct Method: A cost allocation method that assigns service department costs directly to production departments without considering any inter-service department allocations.

Reciprocal Method: A more complex cost allocation method that fully accounts for mutual services provided among service departments, allowing for a two-way allocation of costs.

Cost Allocation Base: A factor or measure used to allocate indirect costs to different cost objects, such as departments or products, often based on usage or activity levels.