Which of the following principles should be applied when the step method of allocating service department costs is used?

What is the Step Allocation Method?

The step allocation method is an approach used to allocate the cost of the services provided by one service department to another service department. The essential steps in this allocation process are as follows:

1. The service department that provides service to the largest number of other service departments or which has the largest percentage of its costs consumed by other service departments allocates its costs to them first. It also allocates its other costs to the operating departments.

2. The service department that provides service to the next-largest number of other service departments or which has the second-largest percentage of its costs consumed by other service departments allocates its costs. Again, its other costs are allocated to the operating departments at this time.

3. The process continues until the service department that provides service to the smallest number of other service departments or has the smallest percentage of its costs consumed by other service departments has allocated its costs. Once these allocations have been completed, the process stops.

Example of Step Allocation Method

A company ranks its service departments by the percentage of its costs that are consumed by other service departments. Based on this analysis, the accounting department is ranked first, followed by the human resources department and then the legal department. The accounting department has $100,000 to allocate, of which $80,000 goes to the human resources department and $20,000 to the legal department. The human resources department goes next; this department must add the $80,000 allocation from the accounting department to its own costs. Human resources allocates $7,000 to the legal department (its other costs are allocated to operating departments). The legal department goes last; this department must add the $7,000 allocation from the human resources department to its own costs. There are no service departments left, so the legal department can only allocate costs to operating departments.

Disadvantages of the Step Allocation Method

At no point in the step allocation process is there any reciprocal allocation of service costs back to the service departments that have already allocated their costs out to other departments. For example, if the human resources department is ranked higher than the legal department, the human resources department can allocate its costs to the legal department, but the legal department cannot allocate its costs back to the human resources department. Because of this lack of reciprocal allocations, the step allocation method is not the most theoretically correct.

Advantages of the Step Allocation Method

Despite the concerns just noted, many organizations employ the step allocation method. The reason for this high usage level is that this approach is clear and easy to use, and can be completed within a relatively short period of time. Given its moderate level of simplicity, controllers who want to minimize the amount of time required to close the books and produce financial statements are more likely to use it, even though the level of cost allocation accuracy provided is not the best.

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68. Products X, Y, and Z are produced from the same process at a cost of $5,200. Five thousand pounds of raw material yields 1,500 X, 2,500 Y, and 1,000 Z. Selling prices are: X $2 per unit, Y $4 per unit, Z valueless. The ending inventory of X is 50 units. What is the value of the ending inventory if joint costs are allocated using net realizable value?
A. $21.67.
B. $31.20.
C. $40.00.
D. $42.00.

75. Lankip Company produces two main products and a by-product out of a joint process. The ratio of output quantities to input quantities of direct material used in the joint process remains consistent from month to month. Lankip has employed the physical-volume method to allocate joint production costs to the two main products. The net realizable value of the by-product is used to reduce the joint production costs before the joint costs are allocated to the main products. Data regarding Lankip's operations for the current month are presented in the chart below. During the month, Lankip incurred joint production costs of $2,520,000. The main products are not marketable at the split-off point and, thus, have to be processed further.

The amount of joint production cost that Lankip would allocate to the Second Main Product by using the physical quantities method to allocate joint production costs would be
A. $1,200,000
B. $1,260,000
C. $1,500,000
D. $1,575,000

81. The Freed Company produces three products, X, Y, and Z from a single raw material input. Product Y can be sold at the split-off point for total revenues of $50,000 or it can be processed further at a total cost of $16,000 and then sold for $68,000. Product Y
A. should be sold at the split-off point, rather than processed further.
B. would increase the company's overall net income by $18,000 if processed further and then sold.
C. would increase the company's overall net income by $68,000 if processed further and then sold.
D. would increase the company's overall net income by $2,000 if processed further and then sold.

Which of the following principles should be applied when the step method of allocating service department cost is used?

What is the order of allocation under the step cost allocation method?

When allocating service department costs companies should use?

What are the 3 allocation methods?