Unlike direct method, the Step Method takes interdepartmental services into account,

though not all of them. In order to performed step down method, the service departments
must be lined up in some sort of order. Different order may result in different allocations and
overhead rate. Here, in chart A, we assumed that Engineering and Production Control
department provides the greatest amount of service to other departments. Firstly we
allocated $310,000 Engineering and Production Control department cost to all of the other
departments, including another service departments Materials Management and the
operating departments according to their percentage allocation (30%, 50% and 20%). Then
we allocated $365,000 Materials Management cost which consists of $272,000 before
allocation allocate plus the $93,000 allocated cost from Engineering department to the
operating departments. After allocating all the service department costs, Machining and
Assembly departments would have $572,111 and $79,889 total allocation each, which
would be used to obtain overhead rates based upon 10,000 machine hours and 200,000
direct labor hours. The overhead rate of $57.21/machine hour and $28.99/labor hour would
help the management of the operating departments to make wise use of services provided
by service departments.

In chart B, we assume that Materials Management provides the greatest amount of service
to other departments. First, we start allocating from the Materials Management department
and disregard the previous Engineering and Production Control department. We allocate
the cost of 272,000 to all of the operating departments, starting from machining and
assembly. We allocate only the 272,000 to the operating departments based on their
percentage allocation (20% and 70%). The rest of the 10% is accounted for in the
Engineering and Production Control department. After allocating all the service department
costs, we observe $54,000 allocated to machining and $190,400 allocated to assembly. We
can then take the total amount allocated to each department and divide them by the cost
drivers in order to find the overhead rate of $62.98/Machine hour and $26.11/labor hour.
This will provide further insight into the different overhead rate that results from different
allocation methods.