Chapter 18

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18-23Departmental Cost Allocation in Profit SBUs 1. Beef Barn: 3,000/6,000 x $24,000 = $12,000 Fish Bowl: 3,000/6,000 x $24,000 = $12,000 This is equivalent to charging each restaurant $4 ($24,000/6,000) per table. Since the usage of the baking area is equal, most would agree that an equal share of the total cost is appropriate. 2. One approach would be to use the allocation approach in (1) above, noting that total costs are now $12,000 fixed cost and unit variable cost is still $2 ($12,000/6,00
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    18-23 Departmental Cost Allocation in Profit SBUs 1. Beef Barn: 3,000/6,000 x $24,000 = $12,000 Fish Bowl: 3,000/6,000 x $24,000 = $12,000 This is equivalent to charging each restaurant $4 ($24,000/6,000) per table. Since the usage of the baking area is equal, most would agree that an equal share of the total cost is appropriate. 2. One approach would be to use the allocation approach in (1) above, noting that total costs are now $12,000 fixed cost and unit variable cost is still $2 ($12,000/6,000). Thus total cost is now $12,000 + $2 x (2,000 + 3,000) = $22,000. The per table cost is now $22,000/5,000 = $4.40 and the allocation is: Beef Barn: 2,000 x $4.40 = $8,800 Fish Bowl: 3,000 x $4.40 = $13,200 The manager of the Beef Barn is probably not too happy with this result, since the Barn’s sales are down 1/3, but baking has not decreased as much. Why? The manager may need a brief explanation of the effect of increasing unit costs when fixed costs don’t change and activity levels decline. But th e manager of the Fish Bowl is most likely to be angry, because the Bowl hasn’t changed at all, but its unit costs have gone up by $.40, and total costs have increased $1,200. An un-motivating deficiency of this allocation method is thus that the activity levels in each unit can affect total activity, and therefore affect the amount of cost allocated to each unit.  A way to solve this deficiency is to use a different approach, based upon dual allocation, where variable costs are traced directly to the user, and fixed costs are allocated on some logical basis. In this case, suppose we split fixed costs evenly, because, on the average, the Bowl and the Barn have approximately equal activity levels. Beef Barn: 2,000 x $2 + ($6,000) = $10,000 Fish Bowl: 3,000 x $2 + ($6,000) = $12,000 This result is much more motivating, since the variable costs are traced directly, and the fixed costs are fairly allocated. Now, what happens if the average activity levels are quite different?  Exercise 18-23 (continued) Then the fixed costs should be allocated on the basis of the proportion of the long-run average usage. For example, if the average long-run usage of the Fish Bowl is 3,000 tables, and the long-run usage of the Beef Barn is 2,000, then the fixed costs should be allocated as follows: Beef Barn: $12,000 x 2/5 = $4,800 Fish Bowl: $12,000 x 3/5 = $7,200  18-24 Allocation of Marketing and Administrative Costs; Profit SBUs 1. The 2005 allocation using revenue as a base: Lower Middle Upper School School School Total Tuition revenue $1,500 $500 $2,000 $4,000 % of total 37.50% 12.5% 50% 100%  Allocation of Marketing and  Administrative cost $450 $150 $600 $ 1,200 2. Allocating costs solely on the basis of revenue can penalize growing units, or units which have a temporary, unusually high activity level. In this example, the Lower School’s increased volume probably had little effect on its actual per-student usage of marketing and administrative costs, but the Lower School now bears a much greater share of these costs, because the other two schools showed no growth.  18-25 Allocation of Administrative Costs The cost driver per unit appears to be the degree of luxury, which is measured by average rent. Total revenue used as a cost driver would take into account both the number of units and average rent, and therefore would provide a reasonable basis for allocating the costs to be billed to the apartment complexes. Each unit would in effect pay a portion of the management fee in proportion to its rent.  Apartment Complex No. of Units  Average Rent Total Rental Revenue % of Total Rental Revenue  Allocation of Management Fee of $16,050 Pinnacle Point 100 $720 $72,000 12.45% $1,998.23 Whispering Woods 355 540 191,700 33.16% 5,322.18 Hollow Rock 300 425 127,500 22.05% 3,539.02 College Villa 550 340 187,000 32.34% 5,190.57 TOTAL $578,200 $16,050.00
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