List three reasons why service department costs should be allocated to production and explain the difference between the direct method and the step-down method of allocating service costs
Reasons why companies allocate service department costs to production include the following:
1. To provide more accurate product cost information.
2. To improve decisions concerning scarce resources.
3. To hold service departments accountable for the costs they incur.
4. To hold producing departments accountable for the services they consume.
The direct method differs from the step-down method in that the direct method does not allocate service department costs to other service departments. The direct method ignores the fact that service departments often provide services to other service departments and only allocates service department costs to producing departments. The step-down method, on the other hand, allocates service department costs to other service departments as well as to producing departments. The step-down method allocates costs in a sequential manner and typically starts by allocating the costs incurred by the service department that either provides the greatest percent of service to other service departments or has incurred the largest amount of costs.
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