What are the two most frequently used methods of distributing service department costs to production departments?

Following chart depicts the methods of re-distribution of service department costs to production departments:

(i) Direct Re-Distribution Method:

Under this method, the costs of service departments are directly apportioned to production departments without taking into consideration any service from one service department to another service department. Thus, proper apportionment cannot be done and the production departments may either be overcharged or undercharged. The share of each service department cannot be ascertained accurately for control purposes. Budget for each department cannot be prepared thoroughly. Therefore Department Overhead rates cannot be ascertained correctly.

Illustration 1:

In a light engineering factory, the following particulars have been collected for the three months’ period ended on 31st March, 2012. You are required to re-apportion the service departments’ expenses to production departments.

Apportion the expenses of service department S2 in proportion of 3: 3: 4 arid those of service department S1 in the ratio of 3: 1: 1 to departments P1, P2 and P3 respectively.

Solution:

(ii) Step Distribution Method:

Under this method the cost of most serviceable department is first apportioned to other service departments and production departments. The next service department is taken up and its cost is apportioned and this process goes on till the cost of the last service department is apportioned. Thus, the cost of last service department is apportioned only to the production departments.

Illustration 2:

A manufacturing company has two Production Departments, P1 and P2 and three Service Departments, Time-keeping, Stores and Maintenance. Time-keeping department is rendering services to two production departments and two other service departments, stores department is rendering services to maintenance department along with production departments and maintenance department is rendering services to production departments only. The Departmental Summary showed the following expenses for July, 2011.

The most important limitation of this method is that cost of one service centre to other service cost centres is ignored and thus the cost of individual cost centres are not truly reflected.

(iii) Reciprocal Services Method:

In order to avoid the limitation of Step Method, this method is adopted. This method recognizes the fact that if a given department receives service from another department, the department receiving such service should be charged. If two departments provide service to each other, each department should be charged for the cost of services rendered by the other.

There are three methods available for dealing with inter-service departmental transfer;

(a) Simultaneous Equation Method,

(b) Repeated Distribution Method and

(c) Trial and Error Method.

(a) Simultaneous Equation Method:

Under this method, the true cost of the service departments are ascertained first with the help of simultaneous equations; these are then redistributed to production departments on the basis of given percentage. This method is preferable and is widely used even if the number of service departments are more than two. Due to the availability of computer it is not difficult to solve sets of simultaneous equations. Following illustration may be taken to discuss the application of this method.

Illustration 3:

A company has three production departments and two service departments, and for a period the departmental distribution summary has the following totals: