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How can you use the step-down allocation method for project cost allocation?

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If you are managing a project that involves multiple departments or units, you need to allocate the costs of the shared resources and services among them. One way to do this is to use the step-down allocation method, which distributes the costs of each support unit to the operating units and other support units based on a certain order and percentage. In this article, you will learn how to use the step-down allocation method for project cost allocation and what are its advantages and disadvantages.

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Asha Kanta Sharma

Manager - Finance & Accounts @ Opendoors Fintech | Financial Accounting

1 What is the step-down allocation method?

The step-down allocation method is a technique that assigns the costs of the support units, such as administration, human resources, or IT, to the operating units, such as production, sales, or marketing, and to the other support units that benefit from their services. The allocation is done in a sequential order, starting from the support unit that provides the most services to the others and ending with the one that provides the least. The costs of each support unit are allocated based on a predetermined percentage or rate, which can be based on different criteria, such as revenue, headcount, or usage. Once a support unit's costs are allocated, they are not reallocated to other support units.

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Asha Kanta Sharma

Manager - Finance & Accounts @ Opendoors Fintech | Financial Accounting
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The step-down allocation method is a cost allocation technique used to distribute indirect costs among different departments in a sequential manner. It involves identifying cost centers and departments, determining the sequence of resource usage, identifying primary and secondary cost centers, allocating direct costs, adjusting secondary costs, continuing sequential allocation, repeating adjustments, and continuing iterations. The total allocated costs for each department are then calculated. The choice of method depends on the project's nature, resource flow, and organizational preferences.

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2 How to use the step-down allocation method?

To use the step-down allocation method for project cost allocation, you need to identify the support units and the operating units involved in the project and their direct costs. Then, determine the order of allocation for the support units based on the amount of services they provide to the others. Select a suitable allocation base for each support unit, such as revenue, headcount, or usage, and calculate the allocation rate or percentage for each operating unit and support unit that receives its services. Subsequently, allocate the costs of each support unit to the operating units and the other support units based on the allocation rate or percentage. Avoid allocating the costs of a support unit to another support unit that has already been allocated. Finally, repeat this process until all the support units' costs are allocated.

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cma Madan Mohan Bhattacharyya

Qualified Member of Chartered Public Finance and Accountants(UK)
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Step down allocation method to be used before allocation of cost to the respective units. First of all we will have to assess the value of support cost of each unit on the basis of the benefits expected to be received. Allocation to be made accordingly on some sceintific predetermined methods. This process to be reviewed in each month on the basis of actual benefits received from the respective units and revised allocation to be made accordingly.

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3 What are the advantages of the step-down allocation method?

The step-down allocation method is more accurate and realistic than the direct allocation method, which ignores interdependencies among support units. Additionally, it is simpler and easier to apply than the reciprocal allocation method, which requires solving a system of equations. The step-down method also reflects the relative importance and contribution of each support unit to the project by allocating their costs in a sequential order. Thus, it has some advantages over other cost allocation methods.

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4 What are the disadvantages of the step-down allocation method?

The step-down allocation method has some drawbacks, such as its reliance on arbitrary and subjective decisions. This method is not always consistent or fair, as it does not allocate the costs of a support unit to another support unit that has already been allocated. Additionally, it may not accurately capture the true costs and benefits of shared resources and services, as it does not consider the quality, efficiency, or value of each support unit.

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5 How to improve the step-down allocation method?

To improve the step-down allocation method for project cost allocation, you can use multiple allocation bases or rates for each support unit, based on the nature and type of services they provide. You can also employ a weighted average or a ranking system to determine the order of allocation for the support units, rather than relying on a single criterion or subjective judgment. Additionally, you can use a feedback loop or a sensitivity analysis to adjust the allocation rates or percentages for each support unit, based on the feedback or results of previous allocations.

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6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can you use the step-down allocation method for project cost allocation?

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1 What is the step-down allocation method?

2 How to use the step-down allocation method?

3 What are the advantages of the step-down allocation method?

4 What are the disadvantages of the step-down allocation method?

5 How to improve the step-down allocation method?

6 Here’s what else to consider

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