Direct Method of Allocation The direct method allocates costs of each of the service departments to each operating department based on cach department's share of the allocation base. Services used by other service departments are ignored. This means the direct method does not recognire service performed by other service departments. For example, if Service Department A ses some of Service Department B's services, these services would be ignored in the cost allocation process Because these services are not allocated to other service departments, some accountants believe the direct method is not accurate, Let's look at another example. A company has 2 service departments, Maintenance and Administration, and 2 operating departments (Department 1 and 2 for simplicity). The costs of the maintenance department are allocated based on the machine-hours used. For the administration department, the cost allocation is based on the number of employees. The following information is provided: Service Dept Operating Dept Maintenance Administration 1 2 Costs 18,000. .00 $4,000 $32,000 $36,000 Machine-hours used 1,000 2,000 2,500 500 2.500 3, Number of Employees 100 200 250 160 360 250 Remember how we calculate predetermined overhead rates? We will need that same formula again. The formula to calculate the allocation rate will be slightly modified for service department cost but will be: Service Dept Cost TOTAL Cost Driver (operating depts only) Notice, we use the operating department cost drivers only since we are allocating the service department cost to operating departments only and not to another service department. Maintenance uses machine-hours as the cost driver or basis and Administration uses number of employees. We can calculate the service department allocation rates as follows: Maintenance Dept Cost = $8,000 =$8,000 = $2 per machine hour TOTAL Machine Hours (operating depts only) (1,500 + 2,500) 4,000 Administration Dept Cost TOTAL Employees (operating depts only) = $4,000 (250 + 150) =$4,000 400 = $10 per employee To allocate the service department costs to each operating department, we will take the amount of the cost driver (machine hours for maintenance and employees for administration) x the allocation rate we just calculated. Direct Method of Allocation The direct method allocates costs of each of the service departments to each operating department based on cach department's share of the allocation base. Services used by other service departments are ignored. This means the direct method does not recognire service performed by other service departments. For example, if Service Department A ses some of Service Department B's services, these services would be ignored in the cost allocation process Because these services are not allocated to other service departments, some accountants believe the direct method is not accurate, Let's look at another example. A company has 2 service departments, Maintenance and Administration, and 2 operating departments (Department 1 and 2 for simplicity). The costs of the maintenance department are allocated based on the machine-hours used. For the administration department, the cost allocation is based on the number of employees. The following information is provided: Service Dept Operating Dept Maintenance Administration 1 2 Costs 18,000. .00 $4,000 $32,000 $36,000 Machine-hours used 1,000 2,000 2,500 500 2.500 3, Number of Employees 100 200 250 160 360 250 Remember how we calculate predetermined overhead rates? We will need that same formula again. The formula to calculate the allocation rate will be slightly modified for service department cost but will be: Service Dept Cost TOTAL Cost Driver (operating depts only) Notice, we use the operating department cost drivers only since we are allocating the service department cost to operating departments only and not to another service department. Maintenance uses machine-hours as the cost driver or basis and Administration uses number of employees. We can calculate the service department allocation rates as follows: Maintenance Dept Cost = $8,000 =$8,000 = $2 per machine hour TOTAL Machine Hours (operating depts only) (1,500 + 2,500) 4,000 Administration Dept Cost TOTAL Employees (operating depts only) = $4,000 (250 + 150) =$4,000 400 = $10 per employee To allocate the service department costs to each operating department, we will take the amount of the cost driver (machine hours for maintenance and employees for administration) x the allocation rate we just calculated