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Service Centers – A Multi-Purpose Management and Allocation ToolWhen you break it down, the real purpose for developing an indirect rate structure is to accurately allocate indirect costs to your products and services. Accurate allocations of indirect costs provide a better understanding of the “true” cost of your products and services and consequently what pricing is required to ensure a profitable return for your efforts. Properly and efficiently allocating each individual indirect costs each time it is incurred is inefficient and open to the incurrence of errors and cost misallocations. The use of service centers to accumulate indirect support costs that benefit more than one indirect cost pool or cost objective and allocating the composite of these costs on an established basis representative of their usage simplifies the allocation process. The accumulation of these support costs in one place also provides management with a clearer picture of the actual cost of providing the services involved facilitating the make-or-buy/outsourcing decisions regarding the services involved. The inclusion of support costs allocated via a general and administrative or overhead rate calculation broadly applies these costs over all efforts on a broad brush basis with no recognition of usage or variable cost utilization. Some examples of service centers and the costs they accumulate that might be established include:
Once your service centers are established you will need to define the basis and process for allocating the costs accumulated in the service center. Careful consideration must be given to determining the allocation basis that most accurately represents the consumption or usage of the efforts provided by the subject service. Common metrics utilized include square footage of the facility, headcount, or an actual documented usage. Just as important, the metric chosen must be easily calculated and verifiable (i.e., audited). There are multiple allocation practices, including many that can become a mathematical nightmare with minimal impact on the accuracy of the allocation. Two methods for allocation that are relatively simple and easily applied include the direct allocation and the step-allocation methods. With either method, it is important to remember that once a service center’s costs have been allocated, no other service center’s costs can be allocated to it. The metric used to allocate a given service center should exclude the service center itself to prevent allocating costs back on itself. Once the service center has been fully allocated, no costs are to remain in the service center. Direct AllocationThe direct allocation method is a simple allocation of the costs accumulated in the service center based on its established basis of allocation. The total cost accumulated in the specific service center is allocated and the service center balance is brought to zero and the end of each allocation period (i.e., month). Once all costs in the service center are allocated no further costs are to be allocated to it. Step AllocationThe step method of allocation is more accurate than the direct method requiring the establishment of a hierarchy of allocation. First, one service center is completely allocated, including other applicable service centers, and then the next service center would be allocated until all service centers have been allocated. Whichever method of allocation is selected, management must ensure that the service center cost has been completely allocated and the purpose and cost content of the service center and the allocation method utilized are fully defined in written policies and procedures. Have a question specific to your company? Contact Neena Shukla, Partner and Government Contracting Team Leader. Partner, Government Contracting Team Leader Neena has extensive experience leading and managing assurance and consulting engagements for government contractors. She has a deep background advising on SEC compliance, mergers and acquisitions due diligence, revenue recognition, stock compensation, employee benefit plan audits, cybersecurity, fraud and forensic accounting. The content of this post is accurate as of the date below. Always ensure you are reviewing the most recent information available. Contact your tax advisor if you need clarification. SHARE THIS POST:Related Posts
As Internet Explorer will discontinue browser security updates by August of 2021, this site is best viewed using Google Chrome, Safari or Microsoft Edge. Click to Continue What is the most accurate method of allocating service department costs?The reciprocal method is the most accurate of the three methods for allocating service department costs, because it recognizes reciprocal services among service departments.
When allocating service department costs companies should use?Each service department should have at least one variable and one fixed cost pool. When allocating costs of service departments, using budgeted cost rates rather than actual cost rates protects the using departments from price changes and inefficiencies in the service departments.
What process is used to allocate support department costs?There are three methods of allocating support department costs: the direct, step-down and reciprocal. The key differences among the methods are the assumptions as to how services provided by one support department are allocated to other support departments.
What is the cost allocation technique?Cost allocation is the process of identifying, accumulating and assigning costs to specific cost objects. A cost object can be a specific product or product line, a particular service you offer, a production-related activity or a department or division in your company.
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Which of the following techniques provides the most accurate allocation of service department costs?
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