Service departments are those departments which provide support to production departments but do not engage directly in the production of the products e.g. the accounting department, maintenance department, and the legal department. Service departments provide services to each other and at the same time to the production department. The methods of allocating service costs include:
- Direct Allocation Method
- Step-wise Method
- Reciprocal Method
The service costs are only allocated to the production department according to the usage of the services provided.
Some of the costs of the reciprocal services will be recognized although only to some extent. The steps followed include:
Choose one of the service departments and allocate its costs to all the other departments including the other service departments. Normally the basis of choosing that service department to start with is the service department that provides services to the greatest number of other departments.
Another service department is chosen and its total costs allocated the remaining departments excluding the first service departments.
Repeat the process until all the service department costs have been allocated to the production departments.
This method fully considers all reciprocal services. It is the most precise in technically finished method. This method employ, the following techniques:
- Simultaneous Equation
- Matrix Algebra