1. EMBA Presentation November 19,2016
Cost Allocation

2. Cost Allocations Involve:
Common Costs
Joint Costs

3. 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

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

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

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

8. 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

10. Comparison of the Three Methods
Method Select White Knotty Total
Physical units
Split off
NRV

11. So, which is the best method?

12. None . . . they are all arbitrary

13. 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

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

15. Direct Method Allocations

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

17. Step Down Allocations

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

19. Reciprocal Allocations

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

21. 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

22. 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

23. Summary Reason for cost allocations Allocating joint costs
Allocating common costs

24. Copyright by Frank Ilett, 2016