Allocate Single Cost Pool to Users 1

Have you ever been here? 2

Terminal Learning Objective Task: Allocate Single Cost Pool to Users Condition: You are training to become an ACE with access to ICAM course handouts, readings, and spreadsheet tools and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors Standard: with at least 80% accuracy Explain how poor cost information encourages undesired behaviors Calculate driver rate Calculate proportion 3

A Broad Definition of Managerial Costing raw accounting data managerial costing translation managerially useful information 4

Why Is This Translation Needed? Accounting Systems usually measure input or source costs Labor, overhead, materials Salaries, benefits, supplies, contracts Managers want measurements based on output or consumption Product, service, project Consuming organization, customer 5

Managerial Costing Terms raw accounting data managerial costing translation managerially useful information = cost pool method of distribution cost object 6

Terminology Cost pool: Cost pool: An aggregation of incurred or source costs to be distributed Examples: Salary and benefits, supplies, travel, etc. in an airfield operations center Utility bills for a garrison cost pool 7

Terminology Method of distribution: Method of distribution: The mechanics of deriving management information from the cost pool Example: Determine unit cost by adding all input costs and dividing by number of units method of distribution 8

Terminology Cost Object: Cost Object: A view of cost needed by management Examples: 120mm tube product cost Morale, welfare, recreation cost Armor school cost cost object 9

What is Allocation? Allocation: Allocation: A method of distribution that distributes cost pool to cost objects in the same proportion as cost driver Example: Distributing the cost of utilities to occupants in the same proportion as space occupied allocation based on cost driver 10

The Mechanics of Allocation Allocation is a basic technique of activity based costing (ABC) Becoming an expert is required but easy Allocation mechanics excel spreadsheet makes it even easier allocation based on cost driver 11

Two Allocation Methods Rate Method: Rate Method: Uses a computed rate per driver unit Proportion Method: Proportion Method: Computes a proportional share of the total cost based on driver usage Both Methods Yield same results Represent the same underlying algebra 12

Reconciling the Two Methods Number of Driver Units Used Total Number of Driver Units * Total Cost Pool Equals Proportion Method 13

Reconciling the Two Methods Total Cost Pool Total Number of Driver Units * Number of Driver Units Used Equals Rate Method 14

Split the Dinner Check Thank You Fillet and Lobster Chicken Kiev Top Sirloin Caesar Salad 9.00 Coffee 2.00 House Wine Champagne Ice Cream 4.00 Chocolate Cheesecake 6.00 Sampler Soup/Salad 8.00 Aperitif 7.00 Total $ Chez Paris Bob Carol Ted Alice 15

Identifying Key Information What is the cost pool? The dinner check of $160 What are the cost objects? Bob, Carol, Ted and Alice What is the cost driver? Number of persons (or eaters) 16

Identifying Key Information What is the cost pool? The dinner check of $160 What are the cost objects? Bob, Carol, Ted and Alice What is the cost driver? Number of persons (or eaters) 17

Identifying Key Information What is the cost pool? The dinner check of $160 What are the cost objects? Bob, Carol, Ted and Alice What is the cost driver? Number of persons (or eaters) 18

Identifying Key Information What is the cost pool? The dinner check of $160 What are the cost objects? Bob, Carol, Ted and Alice What is the cost driver? Number of persons (or eaters) 19

Allocation Mechanics.xls 20

Allocation by Rate Method First, calculate the driver rate: Total cost pool Total driver units Cost pool = $160 Total driver units = 4 eaters Rate = $40/eater 21

Allocation by Rate Method First, calculate the driver rate: Total cost pool Total driver units Cost pool = $160 Total driver units = 4 eaters Rate = $40/eater 22

Allocation by Rate Method First, calculate the driver rate: Total cost pool Total driver units Cost pool = $160 Total driver units = 4 eaters Rate = $40/eater 23

Allocation by Rate Method Second, multiply by driver units used by each cost object: Bob= 1 eater * $40/eater = $40 Carol = 1 eater * $40/eater = $40 Ted = 1 eater * $40/eater = $40 Alice = 1 eater * $40/eater = $40 What if Bob and Carol are a couple and Bob is paying for them both? 24

Allocation by Rate Method Second, multiply by driver units used by each cost object: Bob= 1 eater * $40/eater = $40 Carol = 1 eater * $40/eater = $40 Ted = 1 eater * $40/eater = $40 Alice = 1 eater * $40/eater = $40 What if Bob and Carol are a couple and Bob is paying for them both? 25

Allocation by Rate Method Second, multiply by driver units used by each cost object: Bob= 1 eater * $40/eater = $40 Carol = 1 eater * $40/eater = $40 Ted = 1 eater * $40/eater = $40 Alice = 1 eater * $40/eater = $40 What if Bob and Carol are a couple and Bob is paying for them both? 26

Allocation by Rate Method 27

Allocation by Proportion Method First, calculate each cost object’s proportion: Driver units used Total driver units Bob= 1 eater/4 eaters = 25% Carol = 1 eater/4 eaters = 25% Ted = 1 eater/4 eaters = 25% Alice = 1 eater/4 eaters = 25% 28

Allocation by Proportion Method First, calculate each cost object’s proportion: Driver units used Total driver units Bob= 1 eater/4 eaters = 25% Carol = 1 eater/4 eaters = 25% Ted = 1 eater/4 eaters = 25% Alice = 1 eater/4 eaters = 25% 29

Allocation by Proportion Method Second, multiply each cost object’s proportion by total cost pool Bob= 25% * $160 = $40 Carol = 25% * $160 = $40 Ted = 25% * $160 = $40 Alice = 25% * $160 = $40 What if Bob and Carol are a couple and Bob is paying for them both? 30

Allocation by Proportion Method Second, multiply each cost object’s proportion by total cost pool Bob= 25% * $160 = $40 Carol = 25% * $160 = $40 Ted = 25% * $160 = $40 Alice = 25% * $160 = $40 What if Bob and Carol are a couple and Bob is paying for them both? 31

Allocation by Proportion Method Second, multiply each cost object’s proportion by total cost pool Bob= 25% * $160 = $40 Carol = 25% * $160 = $40 Ted = 25% * $160 = $40 Alice = 25% * $160 = $40 What if Bob and Carol are a couple and Bob is paying for them both? 32

Allocation by Proportion 33

The Results 34

Learning Check What is the rate per hour when the cost pool totals $30,000 and the total hours are 500? One of the cost objects uses 50 hours or resources from the cost pool described above. What is its proportion? 35

Cross Subsidization Consumption Cost allocation Is This Fair? Consumption Cost allocation 36

Incremental Effects What Happens if Bob Spends $10 More? Original Incremental Change Bob ConsumesBob Pays 37

Incremental Effects What Happens if Bob Spends $10 Less? Bob ConsumesBob Pays Incremental Savings Decreased Amount 38

Allocation: a Zero-Sum Game The Total is Constant Changing Allocation Basis Simply Redistributes Cost Increased Allocation for One Cost Object Decreases the Allocation for Other Cost Objects Sometimes Called “Balloon Squeezing” or “Peanut Butter Effect” 39

Measurement Effects Motivation Managerial Costing Inevitably Impacts Behavior Design of Managerial Costing Systems Must Recognize and Anticipate This Effect Consider in this Example What Incentives Exist to Spend More? What Incentives Exist to Spend Less? What Would You Do if You Went to Dinner with Them Tonight? 40

Conclusion Allocation Based on Number of Eaters Failed to Reflect Resource Consumption Results: Unfair Cross-Subsidizations The Creation of Almost Free Incremental Goods Dysfunctional Behavioral Motivation Detailed Record Keeping May be Best in This Problem --i.e. Separate Checks 41

Practical Exercises 42