Service Department Costing


Service Department Costing:

After studying this chapter you should be able to:


Difference between service department and operating department:

Most of the large organizations have both operating departments and service departments. The central purpose of the organization are carried out in the operating department. In contrast, service departments do not directly engage in operating activities. Instead, they provide services or assistance to the operating departments. Examples of operating departments include the surgery departments at hospitals, geography departments at universities, the marketing departments insurance companies, and production departments at manufacturing companies like Mitsubishi, Hewlett-Packard. Examples of service departments include Cafeteria, Internal Auditing, Human Resources, Cost Accounting, and Purchasing.

The costs incurred by service departments are usually allocated to the operating departments, and from the operating departments to the products and services. Many service departments also provide services to other service departments within organization. The cafeteria department, for example, provides food for all employees, including those assigned to other service departments. In return cafeteria department may receive services from other service departments such as from custodial services or personnel. Services provided between service departments are known as interdepartmental services or reciprocal services.

Several different methods are used to allocate costs of service departments to operating departments. Regardless of the allocation method that is ultimately selected, an allocation basemust be selected for each service department.

Selecting Allocation Bases:

Costs are ordinarily assigned to products and services by using a two stage process. In first stage, service department and other costs are allocated to operating departments. In second stage, the costs that have been assigned to operating departments are allocated to products and services. Here we will focus on the first stage, in which service department costs are allocated to operating departments. Click here to continue reading.

Cost Allocations Using Direct and Step Methods:

Three approaches are used to allocate the costs of service department to other departments. These are known as the direct method, the step method, and the reciprocal method. All three methods are discussed in the following paragraphs.

Direct Method of Cost Allocation in Service department costing:

Direct method is a cost allocation method under which any of the allocation base attributable to the service departments themselves is ignored; only the amount of the allocation base attributable to the operating departments is used in the allocation. Click here to continue reading.

Step Method of Cost Allocation in Service Department Costing:

Unlike the direct method, the step method provides for allocation of a service department’s costs to other service departments, as well as to operating departments. The step method is sequential. Click here to continue reading.

Reciprocal Method of Cost Allocation-Service Department Costing:

The reciprocal method gives full recognition to interdepartmental services. Under the step method, only partial recognition of interdepartmental services is possible. The step method always allocates costs forward never backward. The reciprocal method, by contrast, allocates service department costs in both directions. The reciprocal allocation requires the use of simultaneous equations. Click here to continue reading.

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