Question

A consultancy firm has three operating departments; Tax, Estate Planning and Small Business, and two service departments; Internal Accounting and Administrative Services. Only the three operating departments are facing customers. The service departments are offering their services to the operating departments. However, the Administrative Service department is also offering services to the Internal Accounting department. Following information on the five departments: Annual cost ($) Square feet Operating Revenue ($) Tax Estate Planning Small Business Internal Accounting Administrative Services 4,800,000 2,300,000 3,000,000 690,000 450,000 8,000 2,000 4,000 1,000 1,000 8,500,000 3,500,000 6,000,000 The annual costs do not include costs from the service departments. Required: a. Describe the three allocation methods (Direct allocation, Step-down allocation, and Reciprocal allocation) and give your opinion on which method you will recommend the consultancy firm to use. b. Use your chosen method to allocate the service departments annual costs to the three operating departments using Square feet and Operating revenue as allocation base and explain the differences.

Answer 1

Page- consultancy from has three operating departments - tax, estate planning and Small Business and the two service departments internal accounting and administrative Services offering the services. a) The mentioned below three services are the three methods for the consultancy from. ;) Direct method:- Direct allocation method is a technique for changing the costs of storice department to other departments of the business. This method is used to completely load operating depattments with those overhead cost for which they are responsible. +) Step-down Method: Step-down method of cost allocation, unlike di tect method, the step- method allocates the cost of service depastment to other service department as well as the operating departments. To ) Reciprocal Method - Reciprocal methed was Simultaneous equations to allocate the cost incurred by service departments to other departments allocation is also made between the service departments. This method results in an accutate distribution of cost.

Page 2 Direct need -allocation to change method the of these three methods is most useful as it is costs of service. Direct Methodo- Total Tax Estate Small Planning Business Operating Revenue 8150,000 3,50 00 00 60,00,000 | Annual cost-) 4,800,000 2,300,000 3,009000 134167 230,000 Internal accounting (-) 6,90,000 3,25,833 distribute this on revenuel - ratio (85:35:60) 2,40,000 60,000 1,20,000 Administrative services 4, 56,000 distribute on square feet ratio (8:2:4:1) 5,833 | 10,000 Internal acconiting o/38,000 1,4167 beceive from adminis trative department Profit 31,20,000 10,00,100 26,40,000