Exercise-3: Direct vs step down method of cost allocation

Prozma Company has three service departments and two operating departments. The following is the selected data of five departments:

Required:

1. Allocate the costs of service departments to operating departments assuming the company uses direct method. The allocation basis to be used for distributing service departments’ costs to operating departments are: number of employees for administrative department, square feet of space occupied for janitorial department and machine hours for maintenance department.
2. Allocate the cost of service departments to operating departments assuming the company uses step down method and allocates the costs in the following order: (1). Administrative department (number of employees), (2). Janitorial department (square feet of space occupied), (3). Maintenance department (machine hours).

Solution

1. If the company uses direct method of cost allocation:

Distribution rates:

Administrative department:
$42,000/450 employees* = 93.33333

*300 + 150 = 450 employees

Janitorial department:
$33,900/45,000 sq. ft.* = 0.75333

*10,000  + 30,000 = 45,000 employees

Maintenance department:
$18,000/20,000 machine hours* = 0.9

*5,000 + 15,000 = 20,000 machine hours

2. If the company uses step down method of cost allocation

Distribution rates:

Administrative department:
$42,000/600 employees* = $70 per employee

*30 + 120 + 300 + 150 = 600 employees

Janitorial department:
$36,000/50,000 sq.ft.* = $0.72 per sq. ft.

*5,000 + 10,000 + 35,000 = 50,000 sq. ft.

Maintenance department:
$30,000/20,000 machine hours* = $1.2 per hour

*5,000 + 15,000 = 20,000 hours