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Service Department

See Also:
Administration Expenses
Outsource Definition
Advantages of PEO Services for the Business Owner
Sunk Costs
Joint Costs

Service Department Definition

Many companies require support activities as well as core activities to produce their goods and/or services. Support services, or a service department, do not contribute directly to the production of goods or the providing of services, but they are necessary for the company to operate. In addition, consider service departments, support services, or administrative services support activities.

The costs associated with these support services must be treated in accordance with accepted accounting practices. They also may be allocated to the cost of goods and services produced by the company and/or allocated to other departments within the company. Furthermore, support services costs often comprise a large portion of overhead costs.

Because these activities are not the core activities of the business, managers often must decide whether to keep support service activities in-house or to outsource them. Often an outside organization that specializes in the particular support service in question can perform the activities in a more cost-efficient way. As a result, it may benefit the company to outsource that particular activity.

Service Department Cost Allocation Methods

In accounting, there are several methods for allocating the costs associated with service departments to the products produced by the company and also to the internal departments that benefit from the support services. These cost allocation methods include the following:

Support Services – Examples

Some examples of support service departments that you may commonly find in a company include the following:

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service department, Service Department Definition, Service Department Cost Allocation Methods

Source:

Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.

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Step Method Allocation

Service Department Cost Allocation

In accounting, allocate the costs of support service departments to the different departments within the organization that make use of those support services. There are several methods for allocating the costs of support service departments, including the two following methods:

Step Method Allocation

Using the step method allocation of department costs, allocate some of the service department costs to other service departments. The step method recognizes that service departments provide services to other service departments. Then it allocates some of the costs accordingly.

In the step allocation method, the service department with the largest percentage of costs going to other services departments allocates its costs to those other services departments first. Once you have allocated all of the first departments costs to the other departments, then the step method moves on to the service department. It moves with the second largest percentage of costs going to other services departments. Then it allocates those costs to the remaining service departments.

This continues in this manner until all the service department costs that are being allocated to other service departments have been allocated. Do not allocate the costs backwards. That is, the second department in the step method process does not allocate any costs to the department that went first.

step method allocation

See Also:
Advantages PEO Services for the Business Owner
COGS and the Balance Sheets- Services Based Business
Cost Driver
Cost Center

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Direct Method Allocation

See Also:
Agency Costs
Make-or-Buy Business Decision
Lease Agreements
Lessor versus Lessee
National Association of Professional Employer Organizations (NAPEO)

Service Department Cost Allocation

In accounting, the costs of support service departments are allocated to the different departments within the organization that make use of those support services. There are several methods for allocating the costs of support service departments, including both the direct method allocation and the step method.

Direct Method Allocation

Using the direct method of allocating service department costs, allocate all of the service department costs to production departments. That is, all service department costs end up as overhead costs to production departments. Then, allocate none of the costs incurred from operating a support service department to other service departments; even though other service departments may in fact be utilizing the services provided by that department.

Direct method allocation

 

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