Multi Pool, Multi Cost Object Allocation: Step Down Allocation

Step down allocation is an alternative to direct, simple allocation. It adds some, but not all, overhead to overhead allocations and is useful in some situations. It is a good compromise between direct, simple allocation and the very complex reciprocal allocation.

Step down allocation follows the basic allocation principles describes elsewhere and follows the blog on direct, simple allocation. It addresses the issue raised in that blog concerning the allocation of one overhead cost pool to other overhead cost pools as well as the cost objects.

How Does Step Down Allocation Work?

Consider the illustration above which involves the same four overhead cost pools being distributed to seven cost objects. The difference in this illustration is that the illustration now shows eight additional pathways for allocations.

Step down allocation requires definition of a priority of overhead functions before getting to the mechanics of allocation. In this illustration the 1st cost pool is considered the most important to capture its consumption for all other cost pools and cost objects. So the 1st pool allocates to the 2nd, 3rd, and 4th pools as well as all the cost objects.

Allocation of the 1st pool is then finished and we “step down” to the 2nd pool. That pool allocates to the 3rd and 4th pools as well as the cost objects. The cost allocated includes its own incurred cost plus the cost allocated from the 1st pool.

Allocation of the 2nd pool is then finished and we “step down” to the 3rd pool. That pool allocates to the 4th pool as well as the cost objects. The cost allocated includes its own incurred cost plus the allocations it received from the 1st and 2nd pools.

Allocation of the 3rd pool is then finished and we “step down” to the 4th pool. However, there are no more pools in this example and the 4th pool can only allocate to the cost objects. The cost allocated includes its own incurred cost plus the allocations it received from the 1st, 2nd, and 3rd pools.

Step Down Example

We will continue the example in the Direct, Simple blog where 1000 of facilities cost was allocated. In this example we will consider facilities as the 1st cool pool. Since it now has to allocate to the 2nd, 3rd, and 4th pools we will need square footage in those pools. Let’s assume they each have two thousand square feet.

The first step allocation now looks like:

Note the changes. The total base for square feet has now increased by 6. This slightly changes (lowers) the direct allocation to cost objects. The 2nd, 3rd, and 4th cost pools have now received a total of 21 of facilities’ allocation. This 21 is now included in their cost to be allocated when it is their turn to allocate.

The step down process would then process to the next cost pool, determine its basis of distribution and allocate its cost to the remaining cost pools and to the cost objects. It is possible to stop the step down at any step and allow the remaining pools to use direct, simple methodology. This is not an unreasonable thing to do at some point in the step down process.

Facilities is often one of the larger overhead functions and it may make sense to allocate its cost to other overhead functions. Information systems might be another good category to consider for step down allocation in many organizations. These are also types of overhead where the organization might benefit from cost awareness in the other overhead functions.

I once did a project that distributed overhead cost simply and directly to cost objects. The senior manager expressed concern that his cost object managers would now be much more cost conscious of their facility occupation, but that overhead functions would quickly move into the vacated space. Step down allocation of facilities provided the solution.

I personally witnessed the impact that step down allocation can have. I was only spending a day a week at the organization but had a large, windowed office where I spent little time. After implementing step down allocation the site controller took a hard look as his true space needs and facilities cost. My office was gone the next week!

Step down allocation does a good job of distributing overhead cost in significant cost pools that can have behavioral impact on its consumers. But I’m sure some are wondering about the space that facilities itself occupies. Should it allocate to itself? The next blog on reciprocal allocation shows how this can be done.