1. EMBA Presentation November 17,2012

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

10. Method Select White Knotty Total Physical units.33.32.25.31 Split off.33.35.19.31 NRV.29.38.17.31 Comparison of the Three Methods

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,.46667 )(600,000)0320,000280,000 All IS: (.33333,.66667) 0(2,400,000) 800,0001,600,000 Totals$ 0$ 0$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$ 0$ 0 A/HR (.25,.40,.35)(600,000)150,000240,000210,000 IS (.33333..66667) 0(2,550,000)850,0001,700,000 Totals $ 0$ 0$1,090,000$1,910,000

19. Reciprocal Allocations

20. Reciprocal Method A/HR IS GOVT CORP Costs$ 600,000 $2,400,000 A/HR (.25,.40,.35)(861,538)215,385344,615301,538 IS (.10,.30,.60) 261,538 (2,615,385) 784,615 1,569,231 Totals$ 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

21. Comparison of Results MethodGovernmentCorporate 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, 2012