```EMBA Presentation
November 17,2012
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
 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
Physical Units Method
Board feet
Weighting
Allocation of joint costs
Select
White
Knotty
Total
450,000
750,000
300,000
1,500,000
30%
50%
20%
100%
\$ 90,000
\$ 150,000
\$ 60,000
\$ 300,000
60,000
90,000
15,000
165,000
Total costs
\$ 150,000
\$ 240,000
\$ 75,000
\$ 465,000
Cost per board foot
\$
\$
\$
\$
Separate costs
0.33
0.32
0.25
0.31
Sales Value at Spin Off Method
Select
(450,000 x..35)(750,000 x.40)(300,000 x .19)
Knotty
Total
\$ 157,500 \$ 300,000 \$ 75,000 \$ 532,500
Weighting
Allocation of joint costs
White
30%
56%
14%
100%
\$ 88,732 \$ 169,014 \$ 42,254 \$ 300,000
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
Net Realizable Value Method
Select
(405,000 x.40)(675,000 x.55)(270,000 x .25)
60,000
Total
90,000
15,000
165,000
\$ 102,000 \$ 281,250 \$ 52,500 \$ 435,750
Weighting
Allocated joint costs
Knotty
\$ 162,000 \$ 371,250 \$ 67,500 \$ 600,750
Less separate costs
NRV at split off
White
23%
65%
12%
100%
\$ 70,224 \$ 193,632 \$ 36,145 \$ 300,000
60,000
90,000
15,000
165,000
Total costs
\$ 130,224 \$ 283,632 \$ 51,145 \$ 465,000
Cost per board foot
\$
0.29 \$
0.38 \$
0.17 \$
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
Information Services
Government
Corporate
Total
Percent
40
0.53333
35
0.46667
75
1.00000
Information Services
Hours
Percent
3,000
0.33333
6,000
0.66667
9,000
1.00000
Direct Method
A/HR
Costs
IS
\$ 600,000
\$ 2,400,000
All A/HR:
(.53333, .46667 ) (600,000)
All IS:
(.33333, .66667)
Totals
\$
GOVT
0
\$
CORP
0
\$
0
320,000
280,000
800,000
1,600,000
0 \$1,120,000
\$1,880,000
0
(2,400,000)
0
\$
Step Down Allocations
Information Services
Government
Corporate
Total
Percent
25 0.25000
40 0.40000
35 0.35000
100
1.00000
Information Services
Hours Percent
3,000 0.33333
6,000 0.66667
9,000
1.00000
Step Down Method – A/HR First
A/HR
Cost
A/HR
(.25, .40, .35)
\$ 600,000
\$
GOVT
\$ 2,400,000
(600,000)
IS
(.33333. .66667)
Totals
IS
150,000
\$
CORP
0
\$
0
240,000
210,000
850,000
1,700,000
0 \$1,090,000
\$1,910,000
0
(2,550,000)
0
\$
Reciprocal Allocations
Information Services
Government
Corporate
Total
Percent
25
0.25000
40
0.40000
35
0.35000
100
1.00000
Information Services
Hours
Percent
1,000
0.10000
3,000
0.30000
6,000
0.60000
10,000
1.00000
Reciprocal Method
A/HR
Costs
IS
\$ 600,000
GOVT
\$2,400,000
A/HR
(.25, .40, .35)
(861,538)
IS
(.10, .30, .60)
261,538
(2,615,385)
Totals
\$
\$
0
CORP
215,385
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
0
344,615
301,538
784,615
1,569,231
\$1,129,230 \$1,870,769
Comparison of Results
Method
Government
Corporate
Direct
\$1,120,000
\$1,880,000
\$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
```