 Hello, and welcome to the session. This is Professor Farhad. In this session, we would look at an example for the cost allocation using the step method. I already in the prior session, I cover the direct method, and this lecture can be found on my farhadlectures.com as well as other lectures such as intro to cost allocation. But in this section, I will focus on the step method. And to be consistent, I'm gonna be using the same example that I used in the prior session, which is for the direct method. So we are dealing with a home life insurance company that have two service department, S1 and S2. S1 is the actuarial department, S2 is the premium department, and we have two production department, P1 and P2. P1 is the advertising department, P2 is the sales department. The distribution of each department effort and percentages to other department are shown below. So for example, the actuarial department contribute 80% of the premium, 10% of the advertising, and 10% of the sales. The premium department contribute 20% of the actuarial, 20% of advertising, and 60% of the sales. This is how they are allocated. Let's take a look at the dollar amount. We have $80,000 in the actuarial department. This is coming from here. In the premium, we have $15,000. In the advertising, we have $60,000. And in the sales department, we have right now $40,000 in basically, in a sense, overhead direct operating cost. So how are we gonna allocate now the $80,000 from actuarial? And we always start with the largest or the service department that provide the most. And obviously the actuarial department that provide $80,000 more than the premium. So we're gonna go only one way. So basically what's gonna happen, the service department now in this step method, it's gonna allocate some money to the service department too, then it's gonna allocate some money to the P1 and some money to P2. How are we gonna figure out how much are they going to allocate to each department? Well, here are the percentages. This is at up to 100%, 80 plus 10 plus 10 is 100%. So let me do this step-by-step. 80%, plus 10, plus 10 equal to 100. So the premium department will get 80 divided by 100, which is 80%. And the other department, 10 over 100 or 10%. So let's go ahead and allocate first the actuarial overhead. So 80,000 times 80%, 64,000. So from the 80,000, we're gonna allocate 64,000 to the service department, service department too. And the remainder, 10% of 80,000 is 8,000. We're gonna allocate 8,000 and 8,000. And if you add them up 64, plus 8, plus 80 equal to 80,000, we allocated the 80,000. Now, the second step is we're gonna allocate S2, which is, let me do this in a different color. We're gonna allocate S2, which is now S2 has 15 plus 64, that's 0, 0, 0, 9, 79,000. Now we're gonna allocate 79,000 from S2 to P1 and P2. So simply put, we don't go backward in the step-up method. We don't go backward and allocate anything from S2 to S1, although we are providing S1 with 20%. So simply put that 20%, we don't use simply put. So how are we gonna allocate to the other two departments? Again, the ratio is 20 plus 60 equal to 80. So we're gonna allocate 20 divided by 80, which is again 25%. 25% goes to production, one to advertising. And 60 divided by 80 is 75% goes to P2, which is sales. So now what we have to do is take 79,000 times 25%, and that's equal to 19,750, 19,750. Then we're gonna take 79,000 times 75%, or the remainder of that, which is 59,250. 59,250, and if we add them up, they should add up to 79,000. It means we allocated everything. Now we are done. Now what we do is we add up how much was allocated to P1, 68, 78, 750, 87, 750. And for production too is 40, 48, 9,250. That's 107, 250. And this is how we allocated the service department using the step method, the step method. The last method that we were gonna be using is the reciprocal model. Basically where S1 provide services to S2, S2 provide service to S1, then they provide the allocation to the production department. If you have any questions, any comments, by all means email me. And if you've taken my class, see me in class. If you're studying for your CPA or your CMA exam, as always, study hard. It's good.