Cost Allocation Methods
Don Lowery
University of Phoenix

The focus of this paper is to identify the basic aspects of the direct and step-down methods of cost allocation. Included will be a comparison of the two methods and their strengths and weaknesses.
Direct Method Horngren defines the direct method of cost allocation as “a method for allocating service department costs that ignores other service departments when any given service department’s costs are allocated to the operating departments” (2008, p. 531). This method does not take into account the services provided between departments and allocates costs of those departments directly to operating departments. If a service department, for example, a facilities department, provides a significant amount of service to another service department, perhaps a production floor, cost allocations are not made between the two departments (Unknown, 2009, p. 1). All costs are directly allocated to the operating departments, bypassing the other service departments. The direct method is useful for simple understanding of costs directly accountable to a specific determinant such as square footage of a plant or labor hours of personnel.
Step-Down Method The step-down method of cost allocation is defined by Horngren as “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” (2008, p. 531). The step method is relies on sequence of allocating the costs across departments. The sequence starts with the department that provides the most service to other service departments. Once the costs for this particular department have been allocated, the process continues, department by department, ending with the entity that provides the least amount of service to other departments. Conclusion