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. The direct method allocates costs to the operating departments directly, with no allocations to the other service departments. The three service cost-allocation methods vary in terms of ease and accuracy because of how they approach this problem.
The problem in allocating service department costs is complicated by multiple-department relationships, where each service department may provide service to all of the other departments, including other service departments and itself.
Examples include human resources and information systems departments. Service departments provide services and support to operating departments as well as other support departments. Operating departments directly produce or distribute the company’s output, such as machining and assembly departments. The first step of each method is to classify each organizational unit as either an operating or service department. There are three methods for allocating service department costs: direct, sequential, and reciprocal. If the internal cost for a service is greater than the price charged by an external supplier, the service department could be considered for elimination. In addition, they make it possible to assess the department’s operational efficiency. They’re also valuable for rationing demand for internal services-if no price is charged for a service, for example, the service may be overconsumed by operating departments. First and foremost, service department costs are used to determine the full cost of a product. An accurate, clear understanding of service department costs is valuable in several ways.
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