Why Do We Allocate Service Department Costs To Production Departments

The Reason why Service Department Costs are Often Allocated to Producing Departments: The selection and designation of service department has considerable bearing on effective costing and control. Services available for the benefit of producing departments and other service department can be organized in several ways.

Ways to Allocate Service Department Costs :

(1) establishing a separate service department for each function,

(2) combining several functions into one department, and

(3) placing service costs in a department called “general factory.”

The specific service is not identified if service department costs applicable to producing and service functions are accumulated in a general factory department.

Determination of the kinds and number of service department should consider:

(1) number of employees needed for each service function,

(2) cost of providing the service,

(3) importance of the service, and

(4) assignment of supervisory responsibility.

Establishing a separate department for every service function is rarely done even in large companies. When relatively few employees are involved and activities are closely related, service functions are generally combined for the sake of economy and expediency. Decision with respect to combining service functions is governed by the individual circumstances existing in each company. Since factory overhead rates for job and product costing are calculated for producing departments only, service department costs are transferred to producing departments for rate-setting and variance analysis.

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