Appendix A
Service Department Costing: An Activity Approach

Solutions to Questions
A-1 Interdepartmental service costs exist whenever two service departments perform services for each other. Under the step method, the costs of the service department performing the greatest amount of service for the other service departments are allocated first, the costs of the service department performing the next greatest amount of service are allocated next, and so forth through all the service departments. Once a service department’s costs have been allocated, costs are not reallocated back to it under the step method. A-2 Under the direct method, costs are not allocated between service departments. Rather, all service department costs are allocated directly to operating departments. A-3 If a variable base is used to allocate fixed costs, the costs allocated to one department will depend in large part on what is happening in other departments. For example, ineffectiveness in one department will result in it being relieved of allocated costs, and these costs will be shifted onto other departments. As a consequence, the more efficient departments will be penalized. A-4 In many firms, managers of departments have great latitude over the extent to which their departments will utilize the services offered by the firm’s service departments. In order to encourage the use of certain services which otherwise might not be used (such as performance evaluation and internal auditing), the services are often made “free” to the using departments. A-5 Lubricants, utilities, and factory supervision are all indirect costs of production. Service department costs are similar in that they, too, are indirect costs, incurred to provide essential support services to operating departments. A-6 Three criteria are important in the selection of allocation bases: (1) actual physical consumption or