To apply the step-down method, we choose a sequence of service department allocations, starting with the service department that renders the greatest service (as measured by costs) to the greatest number of other service departments. The last service department in the sequence is the one that renders the least service to the least number of other service departments.

Step-down method:

A step-down method is a method for allocating service department costs that recognizes that some service departments support the activities in other service departments as well as those in operating departments.

STEP-DOWN ALLOCATION
Exhibit 12-4	Facilities	Human	Processing	Assembly	Total
	Management	Resources
Direct department cost before	$1,260,000	$240,000	$1,000,000	$1,600,000	$4,100,000
allocation
Step 1
Facilities	$(1,260,000	(9/27)X	(15/27)X	(3/27)X
Management		$1,260,000	$1,260,000	$1,260,000
		420,000	700,000	140,000
Step 2
Human		($660,000)	(16/80)X	(64/80)X
Resources			$660,000	$660,000
			132,000	528,000
Total cost after
allocation	$0	$0	$1,832,000	$2,268,000	$4,100,000

.

1. How should we determine which of the two service departments provides more service to the other? One way is to carry out step 1 of the step-down method with facilities management allocated first, and then repeat it assuming personnel is allocated first. With facilities management allocated first, $420,000 is allocated to human resources, as shown in Exhibit 12-4.
2. If human resources had been allocated first, (16 96) $240,000 = $40,000 would have been allocated to facilities management. Because $40,000 is smaller than $420,000, facilities management is allocated first. in the sequence is the one that renders the least service to the least number of other service departments. We allocate the costs of one service department at a time, assigning the costs to the producing departments and to the remaining service departments. Once we allocate a departments costs to other departments, we never allocate other service department costs back to it.

In our example, we allocate facilities management department costs first. Why?

Because facilities management renders more support to human resources than human resources provides to facilities management.1 Examine Exhibit 12-4. After allocating facilities management costs, we do not allocate any costs back to facilities management, even though human resources does provide some services to facilities management. The $660,000 human resources costs allocated to the producing departments include the amount allocated to human resources from facilities management ($420,000) in addition to the direct human resources department costs of $240,000.

Examine the last column of Exhibit 12 4. Before allocation, the four departments incurred costs of $4,100,000. In step 1, we deducted $1,260,000 from facilities management and added it to the other three departments. There was no net effect on the total cost.

In step 2, we deducted $660,000 from human resources and added it to the remaining two departments. Again, total cost was unaffected. After allocation, all $4,100,000 remains, but it is all in the processing and assembly departments. None was left in facilities management or human resources.

Comparison of the Methods Compare the costs of the producing departments under direct and step-down methods, as shown in Exhibit 12-5. Note that the method of allocation can greatly affect the costs. Processing appears to be a more expensive operation to a manager using the direct method than it does to one using the step-down method. Conversely, assembly seems more expensive to a manager using the step-down method.

DIRECT VERSUS STEP-DOWN METHOD
Exhibit 12-5	Processing		Assembly
	Direct	Step-Down	Direct	Step-Down
Direct costs	$1,000,000	$1,000,000	$1,600,000	$1,600,000
Allocated from
Facilities Management	1,050,000	700,000	210,000	140,000
Allociated from
Personnel	48,000	132,000	192,000	528,000
Total costs	$2,098,000	$1,832,000	$2,002,000	$2,268,000