Service Department Cost Allocation

Since service departments do not generate revenue themselves and they help other departments, all their costs must be allocated again to other departments. This will be a simple task provided that none of the service departments provides services to other service department(s). Things are complicated when service departments receive services from each other (which is most often the case).

The problem here is that the cost reallocation process of two service departments, both of which benefit from each other, will repeat itself because each of them will receive a portion of reallocated service department costs which have to be allocated again and again. Assume a company has a certain number of production departments and two service departments, A and B, and that both of them receive services from each other. If we reallocate service department A's cost first and service departments B's cost later, department A's balance will no longer remain zero because it will receive a portion of reallocated cost of department B. Thus, we will be forced to repeat the process many times.

Following are the four techniques for reallocation of service department costs for use in the situation described above:

  1. Simultaneous Equation Method
  2. Repeated Distribution Method
  3. Specific Order of Closing Method
  4. Direct Allocation Method

Written by Irfanullah Jan