How to Calculate Reciprocal Method Costing

Costs can be allocated using three different methods.

Cost allocation can be carried out using three methods: the direct method, the sequential method and the reciprocal method. The three methods differ in the manner by which costs are split among the producing departments. There is absolutely no doubt that no matter which method is used, total overhead costs remain unchanged. The reciprocal method recognizes the reciprocal services provided by support departments to other support departments; in other words, it gives full recognition to interdepartmental services. The method is also known as the simultaneous equation method, or the algebraic method.

Things You'll Need

• Calculator
• Cost information

Instructions

1. Determine the total cost of support departments so that the total cost reflects interaction with other support departments. In the example, the human resources (HR) department receives 20 per cent of data processing (DP) services, and data processing receives 10 per cent of human resources output. In the consecutive period, the HR costs were $160,000 and DP costs were $250,000.

2. Form a simultaneous linear equation system. Each equation would be a cost equation for a support department. This will be the total of the department's direct cost and the proportion of service received from the other department. In other words:

   Total Cost = Direct Cost + Allocated Cost.

3. Substitute the data from the example into the equation. Thus ...

   DP = $250000 + 0.1HR and

   HR = $160000 + 0.2DP.

4. Solve the above mentioned simultaneous equations. Hence,

   HR = $160000 + 0.2DP

   HR = $160000 + 0.2 ($250000 + 0.1HR)

   HR =$160000 + $50000 + 0.02HR

   0.98HR = $210000

   HR = $214286

   DP = $250000 + 0.1HR

   DP = $250000 + 0.1 ($214286)

   DP = $250000 + $21429

   DP = $271429

5. Analyze your findings. The total cost for the data processing department is $271,429 and for the human resources department it's $214,286. Both costs aptly reflect all interactions between the two support departments.

Tips & Warnings

• The method is rarely used, as the math and computation can become complex.

References

• College of San Mateo: Support Department Cost Allocation
• Accounting for Management: Reciprocal Method of Cost Allocation-Service Department Costing
• Overhead Cam: White Paper on Reciprocal Allocation
• Managerial Accounting: By Don R. Hansen, Maryanne M. Mowen
• Cost Management: Accounting & Control: By Don R. Hansen, Maryanne M. Mowen, Liming Guan

Resources

• Enotes: Cost Allocation
• All Business: Strategic Cost Accounting helps Create a Competitive Edge
• OSU College of Business: Allocation of Service Department Costs