The allocation method that distributes indirect costs starting with the department that provides the least amount of revenue-generating services is the:

• A. Direct method
• B. Step-down allocation method
• C. Double distribution method
• D. Simultaneous equations method

Answer: (B)

The key idea is allocating service department costs in a sequence so that the costs flow to the operating (revenue-generating) departments in steps. In the step-down method, you pick an order of service departments and, for each one in turn, allocate its total costs to all other departments (both operating and remaining service departments) based on the extent to which each uses that department’s services. After you allocate a department’s costs, you remove it from future allocations and move to the next department in the chosen order. Starting with the department that provides the least amount of revenue-generating services helps keep the allocations simple early on, because its costs have the smallest potential to be redistributed multiple times as you proceed, reducing complexity and the chance of overstating the influence of any single service department. This approach is more accurate than the direct method, which ignores service-to-service transfers, and more practical than the simultaneous equations method, which is mathematically exact but more complex.