Step-Down Method of Cost Allocation

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  • 0:01 What Is the Step-Down Method?
  • 0:40 How the Step-Down Method Works
  • 1:36 Advantages of this Method
  • 2:08 Disadvantages of this Method
  • 2:40 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

The step-down method of cost allocation lets accountants do something that some other forms of cost allocation won't: allocate overhead costs to service departments. However, it's still not a perfect system.

What Is the Step-Down Method?

Being able to properly allocate costs from one department to another is a major task of accounting. After all, properly doing this can help prevent the question that every department head dreads hearing from corporate: 'What do we even pay you for?' There are a number of methods to transfer overhead costs from one department from another. One of these is the Step-Down Method. Unlike some other methods, the step-down method allows you to transfer costs from one service department to another. From there, the costs can be further transferred to departments that make money. Let's examine exactly how the step-down method works.

How the Step-Down Method Works

Let's say you have two service departments in your company: a custodial department and an accounting department. Additionally, you have a sales department, which makes money. Every month, the custodial department performs $20,000 worth of services for the accounting department. Chances are if you didn't have a custodial department, your accounting department would have to pay for this service from an outside provider. The step-down method of cost allocation allows you to treat it like that, even though the money will never leave your organization. The custodial department passes off $20,000 in expenses to the accounting department. The accounting department now treats that $20,000 as part of its overhead expenses; however, the accounting department can now combine that $20,000 in overhead with the money it spent working for the sales department. As you can see, the cost steps down from department to department until it reaches a sales department.

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