The sequential (or step-down) allocation method is a method of allocating support department (or activity) costs that proceeds by choosing the order in which service departments allocate their costs and then allocate costs “forward”, i.e. towards all following service or production departments, and not “backward”, i.e. not towards preceding service departments. It allows partial recognition of service rendered by support departments to other support departments.
This method requires a support department to be ranked (sequenced) in the order in which the step down allocation is to proceed. The costs in the first-ranked support department are allocated to the other support departments and to the operating departments. The costs in the second-ranked support department (which include both the costs initially accumulated and the allocation from the first department) are allocated to the following support departments (not yet allocated) and into the operating departments, but not to the first support department. This procedure is followed until the costs in the last-ranked support department have been allocated to the operating departments. The key is to chose the order in such a way that distortions induced by the ignored services are minimized.
There are two ways to determine in which order service departments should be allocated. The first approach consists in ranking support departments based on the percentage of the support departments’ total support provided other support departments. The support department with the highest percentage of its services to other service departments is allocated first; the support department with the lowest percentage of its services provided to other service department is allocated last. The second approach is very similar but uses amounts rather than percentages. The second approach is a bit longer so more complex, but it is justified when there are huge disparities between the costs of each support department. In the following video, I use the first approach, based on the percentages rather than the amounts:
You can get all the data and solutions by downloading the same Excel as before (I only put this link again in case you missed it the first time).
The sequential allocation method recognizes some, but not all, reciprocal services. This method makes sense if there are huge imbalances in these reciprocal services and a clear “direction” in the cost flows between support departments. However, if the services provided by support departments to each other are well balanced, it will actually introduce more distortions than the direct allocation method because it prevents their “mutual cancellation”. In addition, the allocation rates it computes also give a poor indication about the costs of the services provided by support departments, especially for those which are allocated first. These issues are solved with the reciprocal allocation method.
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