EMBA Presentation November 19,2016 Cost Allocation

Cost Allocations Involve: Common Costs Joint Costs

Purposes of Cost Allocation To provide information for economic decision making To motivate managers To justify costs for reimbursement To measure income and use of assets

Criteria for Allocation of Costs Cause and effect Benefits received Fairness or equity Ability to bear

Steps in Cost Allocation Define the cost objects Accumulate common costs Choose a method for assigning costs

Allocation of Joint Costs Sales value at split-off Physical measure Estimated net realizable value

Sales Value at Spin Off Method Select White Knotty Total (450,000 x.35)(750,000x.40)(300,000x.25) 157,500 $ 300,000 75,000 532,500 Weighting 30% 56% 14% 100% Allocation of joint costs 88,732 169,014 42,254 Separate costs 60,000 90,000 15,000 165,000 Total costs 148,732 259,014 57,254 465,000 Cost per board foot 0.33 0.35 0.19 0.31

Comparison of the Three Methods Method Select White Knotty Total Physical units .33 .32 .25 .31 Split off .33 .35 .19 .31 NRV .29 .38 .17 .31

So, which is the best method?

None . . . they are all arbitrary

Pros and Cons Physical units – is easy to calculate Split-off – may not be appropriate if there is no market at the split-off point NRV – assumes that the greater the end sales dollars, the better it can bear the joint cost

Allocation of Common Costs Direct Method Step-down Method Reciprocal Method

Direct Method Allocations

Direct Method A/HR IS GOVT CORP Costs $ 600,000 $ 2,400,000 $ 0 $ 0 All A/HR: (.53333, .46667 ) (600,000) 0 320,000 280,000 All IS: (.33333, .66667) 0 (2,400,000) 800,000 1,600,000 Totals $ 0 $ 0 $1,120,000 $1,880,000

Step Down Allocations

Step Down Method – A/HR First A/HR IS GOVT CORP Cost $ 600,000 $ 2,400,000 $ 0 $ 0 A/HR (.25, .40, .35) (600,000) 150,000 240,000 210,000 IS (.33333. .66667) 0 (2,550,000) 850,000 1,700,000 Totals $ 0 $ 0 $1,090,000 $1,910,000

Reciprocal Allocations

Reciprocal Method Costs $ 600,000 $2,400,000 A/HR A/HR IS GOVT CORP Costs $ 600,000 $2,400,000 A/HR (.25, .40, .35) (861,538) 215,385 344,615 301,538 IS (.10, .30, .60) 261,538 (2,615,385) 784,615 1,569,231 Totals $ 0 $ 0 $1,129,230 $1,870,769 A = 600,000 + .10 IS IS = 2,400,000 + .25 A IS = 2,400,000 +1 50,000 + .025 IS .9750 IS = 2,550,000 IS = 2,615,385 A = 600,000+.10 (2,615,385) A = 861,538

Comparison of Results Method Government Corporate Direct $1,120,000 $1,880,000 Stepdown Adm first $1,098,000 $1,910,000 Stepdown IT first $1,128,000 $1,892,000 Reciprocal $1,129,230 $1,870,769

Pros and Cons of Methods Direct method – easy but ignores how support departments use each other Step down – widely accepted but requires designation of a “first” department Reciprocal – most accurate but not well understood or widely used

Summary Reason for cost allocations Allocating joint costs Allocating common costs

Copyright by Frank Ilett, 2016