How does the step-down approach begin in cost allocation?

The step-down approach in cost allocation is designed to allocate indirect costs from overhead departments to production departments in a systematic way. It begins by addressing the overhead function that serves the most areas, which is crucial because this ensures that the majority of indirect costs are allocated first where they are most utilized.

By starting with the overhead department that provides services to the largest number of other departments, the step-down method allows for a more accurate representation of costs, as those departments benefiting from multiple services will have their costs properly accounted for. This not only reflects the true usage of resources but also prevents costs from being under-allocated or misrepresented in departments that rely heavily on interdisciplinary support.

Using this method leads to more precise cost information, which is essential for budgeting, pricing decisions, and financial control. Other methods mentioned, such as randomly selecting an overhead department or splitting costs equally, fail to provide the same level of accuracy and practicality in aligning costs with usage patterns within the organization.