Service department definition

A service department is a cost center that provides services to the rest of a company. The manager of a service department is responsible for keeping costs down, or meeting the costs stated in a budget. The services provided by a service department are then allocated to the other departments of a business that use these services.

Some of the costs of a service department may not be allocated elsewhere, due to cost overages that cannot be passed through to other departments (as defined in service agreements that state the costs that can be allocated).

Examples of service departments are:

  • Maintenance department. Bills the production department for labor and equipment consumed during the maintenance of machinery. Costs are commonly accumulated by individual maintenance job for each machine.

  • Janitorial. Bills all departments for cleaning services, frequently on a square footage basis.

  • Purchasing. Bills a variety of departments for its efforts in procuring goods and services for them. The allocation may be based on total dollars purchased or the number of purchase orders placed.

  • Information technology. Bills departments for their use of IT storage, bandwidth, by user, or some other reasonable method of allocation.

Elements of the accounting department can be considered a service department, since payments to suppliers can be traced back to the ordering departments, and customer billings are related to customer-specific profitability tracking.

If the charges of service departments are assigned to the production area, these cost allocations will probably be included in a cost pool, and then allocated to goods produced. This means that some service department allocations may not be charged to expense until several months later, when the related goods are sold and charged to the cost of goods sold account.

There is a moderate trend favoring the outsourcing of service departments, on the grounds that outside suppliers keep tighter control over their costs, and so will charge less than an in-house department. Outsourcing of this type should be adopted with care, to ensure that only non-critical service functions are shifted out of a business.

Related Courses

Activity-Based Costing
Cost Accounting Fundamentals