costacctg13_sm_ch15

costacctg13_sm_ch15 - CHAPTER 15 ALLOCATION OF...

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Unformatted text preview: CHAPTER 15 ALLOCATION OF SUPPORT­DEPARTMENT COSTS, COMMON COSTS, AND REVENUES 15­1 The single­rate (cost­allocation) method makes no distinction between fixed costs and variable costs in the cost pool. It allocates costs in each cost pool to cost objects using the same rate per unit of the single allocation base. The dual­rate (cost­allo cat ion) method classifies costs in each cost pool into two pools—a variable­cost pool and a fixed­cost pool—wit h each pool using a different cost­allo cat ion base. 15­2 The dual­rate method provides informat ion to divisio n managers about cost behavior. Knowing how fixed costs and variable costs behave different ly is useful in decisio n making. 15­3 Budgeted cost rates motivate the manager of the supplier department to improve efficiency because the supplier department bears the r isk of any unfavorable cost variances. 15­4 Examples of bases used to allocate support department cost pools to operating departments include the number of emplo yees, square feet of space, number of hours, and machine­hours. 15­5 The use o f budgeted indirect cost allocat ion rates rather than actual indirect rates has several attractive features to the manager of a user department: a. the user knows the costs in advance and can factor them into ongoing operating cho ices, b. the cost allocated to a particular user department does not depend on the amount of resources used by other user departments, and c. inefficiencies at the department providing the service do not affect the costs allocated to the user department. 15­6 Disagree. Allocat ing costs on “the basis o f est imated long­run use by user department managers” means department managers can lower their cost allocations by deliberately underest imat ing their lo ng­run use (assuming all other managers do not similarly underest imate their usage). 15­7 The three methods differ in how they recognize reciprocal services among support departments: a. The direct (allocation) method ignores any services rendered by one support department to another; it allo cates each support department’s costs direct ly to the operating departments. b. The step­down (allocation) method allocates support­department costs to other support departments and to operating depart ments in a sequential manner that partially recognizes the mutual services provided amo ng all support departments. c. The reciprocal (allo cat ion) method allocates support­department costs to operating departments by fully recognizing the mutual services provided amo ng all support departments. 15­1 15­8 The reciprocal method is theoretically the most defensible method because it fully recognizes the mutual services provided among all departments, irrespect ive of whether those departments are operating or support departments. 15­9 The stand­alo ne cost­allocat ion method uses informat ion pertaining to each user of a cost object as a separate entit y to determine the cost­allocation weights. The incremental cost­allocat ion method ranks the individual users of a cost object in the order of users most responsible for the commo n costs and then uses this ranking to allocate costs among those users. The first­ranked user of the cost object is the primary user and is allocated costs up to the costs of the primary user as a stand­alone user. The second­ranked user is the first incremental user and is allocated the additional cost that arises from two users instead of only the primary user. The third­ranked user is the second incremental user and is allocated the addit iona l cost that arises fro m three users instead of two users, and so on. The Shapley Value method calculates an average cost based on the costs allocated to each user as first the primary user, the second­ranked user, the third­ranked user, and so on. 15­10 All contracts with U.S. government agencies must comply wit h cost accounting standards issued by the Cost Accounting Standards Board (CASB). 15­11 Areas of dispute between contracting parties can be reduced by making the “rules of the game” explicit and in writ ing at the time the contract is signed. 15­12 Companies increasingly are selling packages of products or services for a single price. Revenue allocation is required when managers in charge of developing or market ing individua l products in a bundle are evaluated using product­specific revenues. 15­13 The stand­alone revenue­allocat ion method uses product­specific informat ion on the products in the bundle as weights for allocating the bundled revenues to the individual products. The incremental revenue allocat ion method ranks individual products in a bundle according to criteria determined by management—such as the product in the bundle with the most sales—and then uses this ranking to allocate bundled revenues to the individual products. The first­ranked product is the primary product in the bundle. The second­ranked product is the first incremental product, the third­ranked product is the second incremental product, and so on. 15­14 Managers typically will argue that their individual product is the prime reason why consumers buy a bundle of products. Evidence on this argument could co me fro m the sales of the products when sold as individual products. Other pieces of evidence include surveys of users of each product and surveys o f people who purchase the bundle of products. 15­15 A dispute over allocation o f revenues of a bundled product could be reso lved by (a) having an agreement that outlines the preferred method in the case of a dispute, or (b) having a third party (such as the company president or an independent arbitrator) make a decisio n. 15­2 15­16 (20 min.) Single­rate versus dual­rate methods, support department. Bases available (kilowatt hours): Rockford Practical capacit y 10,000 Expected monthly usage 8,000 1a. Peoria 20,000 9,000 Hammond Kankakee Total 12,000 8,000 50,000 7,000 6,000 30,000 Single­rate method based on practical capacit y: Total costs in pool = $6,000 + $9,000 = $15,000 Practical capacit y = 50,000 kilowatt hours Allocat ion rate = $15,000 ÷ 50,000 = $0.30 per hour of capacit y Rockford 10,000 $3,000 Peoria 20,000 $6,000 Hammond Kankakee Total 12,000 8,000 50,000 $3,600 $2,400 $15,000 Practical capacit y in hours Costs allocated at $0.30 per hour 1b. Single­rate method based on expected monthly usage: Total costs in pool = $6,000 + $9,000 = $15,000 Expected usage = 30,000 kilowatt hours Allocat ion rate = $15,000 ÷ 30,000 = $0.50 per hour of expected usage Rockford Peoria Hammond Kankakee Total Expected monthly usage in hours 8,000 9,000 7,000 6,000 30,000 Costs allocated at $0.50 per hour $4,000 $4,500 $3,500 $3,000 $15,000 2. Variable­Cost Pool: Total costs in pool Expected usage Allocat ion rate Fixed­Cost Pool: Total costs in pool Practical capacit y Allocat ion rate = = = = = = $6,000 30,000 kilowatt hours $6,000 ÷ 30,000 = $0.20 per hour of expected usage $9,000 50,000 kilowatt hours $9,000 ÷ 50,000 = $0.18 per hour of capacit y Peoria $1,800 3,600 $5,400 Hammond Kankakee $1,400 2,160 $3,560 $1,200 1,440 $2,640 Total $ 6,000 9,000 $15,000 Rockford Variable­cost pool $0.20 × 8,000; 9,000; 7,000, 6,000 Fixed­cost pool $0.18 × 10,000; 20,000; 12,000, 8,000 Total $1,600 1,800 $3,400 The dual­rate method permits a more refined allocation of the power department costs; it permit s the use of different allocat ion bases for different cost pools. The fixed costs result from decisio ns most likely associated with the practical capacit y level. The variable costs result from decisio ns most likely associated with monthly usage. 15­3 15­17 (20–25 min.) Single­rate method, budgeted versus actual costs and quantities. 1. a. Budgeted rate = Budgeted indirect costs = $115,000/50 trips = $2,300 per round­trip Budgeted trips Indirect costs allocated to Dark C. Divisio n = $2,300 per round­trip ´ 30 budgeted round trips = $69,000 Indirect costs allocated to Milk C. Divisio n = $2,300 per round­trip ´ 20 budgeted round trips = $46,000 b. Budgeted rate = $2,300 per round­trip Indirect costs allocated to Dark C. Divisio n = $2,300 per round­trip ´ 30 actual round trips = $69,000 Indirect costs allocated to Milk C. Divisio n = $2,300 per round­trip ´ 15 actual round trips = $34,500 c. Actual rate = Actual indirect costs = $96,750/ 45 trips = $2,150 per round­trip Actual trips Indirect costs allocated to Dark C. Divisio n = $2,150 per round­trip ´ 30 actual round trips = $64,500 Indirect costs allocated to Milk C. Divisio n = $2,150 per round­trip ´ 15 actual round trips = $32,250 2. When budgeted rates/budgeted quantit ies are used, the Dark Chocolate and Milk Chocolate Divisio ns know at the start of 2009 that they will be charged a total o f $69,000 and $46,000 respectively for transportation. In effect, the fleet resource becomes a fixed cost for each divisio n. Then, each may be motivated to over­use the trucking fleet, knowing that their 2009 transportation costs will not change. When budgeted rates/actual quant it ies are used, the Dark Chocolate and Milk Chocolate Divisio ns know at the start of 2009 that they will be charged a rate of $2,300 per round trip, i.e., they know the price per unit of this resource. This enables them to make operating decisio ns knowing the rate they will have to pay for transportation. Each can st ill control its total transportation costs by minimizing the number of round trips it uses. Assuming that the budgeted rate was based on honest estimates of their annual usage, this method will also provide an estimate of the excess trucking capacit y (the portion of fleet costs not charged to either divis io n). In contrast, when actual costs/actual quant it ies are used, the two divisio ns must wait until year­ end to know their transportation charges. The use of actual costs/actual quant it ies makes the costs allocated to one divis io n a funct ion of the actual demand o f other users. In 2009, the actual usage was 45 trips, which is 5 trips below the 50 trips budgeted. The Dark Chocolate Divisio n used all the 30 trips it had budgeted. The Milk Chocolate Divisio n used only 15 of the 20 trips budgeted. When costs are allocated based on actual costs and actual quant it ies, the same fixed costs are spread over fewer 15­4 trips result ing in a higher rate than if the Milk Chocolate Divisio n had used its budgeted 20 trips. As a result, the Dark Chocolate Divisio n bears a proportionately higher share of the fixed costs. Using actual costs/actual rates also means then any efficiencies or inefficiencies of the trucking fleet get passed along to the user divis io ns. In general, this will have the effect of making the truck fleet less careful about its costs, although in 2009, it appears to have managed its costs well, leading to a lower actual cost per roundtrip relat ive to the budgeted cost per round trip. For the reasons stated above, of the three single­rate methods suggested in this problem, the budgeted rate and actual quant it y may be the best one to use. (The management of Chocolat, Inc. would have to ensure that the managers of the Dark Chocolate and Milk Chocolate divisio ns do not systemat ically overestimate their budgeted use of the fleet divisio n in an effort to drive down the budgeted rate). 15­18 (20 min.) Dual­rate method, budgeted versus actual costs, and practical capacity versus actual quantities (continuation of 15­17). 1. Charges with dual rate method. Variable indirect cost rate Fixed indirect cost rate = = = $1,500 per trip $40,000 budgeted costs/ 50 round trips budgeted $800 per trip Dark Chocolate Divisio n Variable indirect costs, $1,500 × 30 Fixed indirect costs, $800 × 30 Milk Chocolate Divisio n Variable indirect costs, $1,500 × 15 Fixed indirect costs, $800 × 20 $45,000 24,000 $69,000 $22,500 16,000 $38,500 2. The dual rate changes how the fixed indirect cost component is treated. By using budgeted trips made, the Dark Chocolate Divis io n is unaffected by changes fro m its own budgeted usage or that of other divis io ns. When budgeted rates and actual trips are used for allocat ion (see requirement 1.b. of problem 15­17), the Dark Chocolate Divisio n is assigned the same $24,000 for fixed costs as under the dual­rate method because it made the same number of trips as budgeted. However, note that the Milk Chocolate Divisio n is allocated $16,000 in fixed trucking costs under the dual­rate system, compared to $800 ´ 15 actual trips = $12,000 when actual trips are used for allocat ion. As such, the Dark Chocolate Divisio n is not made to appear disproportionately more expensive than the Milk Chocolate Divisio n simply because the latter did not make the number of trips it budgeted at the start of the year. 15­5 15­19 (30 min.) Support department cost allocation; direct and step­down methods. 1. a. Direct method costs Alloc. of AS costs (40/75, 35/75) Alloc. of IS costs (30/90, 60/90) b. Step­down (AS first) costs Alloc. of AS costs (0.25, 0.40, 0.35) Alloc. of IS costs (30/90, 60/90) c. Step­down (IS first) costs Alloc. of IS costs (0.10, 0.30, 0.60) Alloc. of AS costs (40/75, 35/75) AS IS $600,000 $2,400,000 (600,000) GOVT CORP $ 320,000 $ 280,000 1,600,000 $1,880,000 (2,400,000) 800,000 $ 0 $ 0 $1,120,000 $600,000 $2,400,000 (600,000) 150,000 $ 240,000 $ 210,000 1,700,000 $1,910,000 $ (2,550,000) 850,000 0 $ 0 $1,090,000 $600,000 $2,400,000 240,000 (2,400,000) $ 720,000 (840,000) $ 0 $ 448,000 $1,168,000 GOVT $1,120,000 1,090,000 1,168,000 $1,440,000 392,000 $1,832,000 CORP $1,880,000 1,910,000 1,832,000 0 2. Direct method Step­down (AS first) Step­down (IS first) The direct method ignores any services to other support departments. The step­down method partially recognizes services to other support departments. The informat ion systems support group (with total budget of $2,400,000) provides 10% of its services to the AS group. The AS support group (with total budget of $600,000) provides 25% of its services to the informat ion systems support group. When the AS group is allocated first, a total of $2,550,000 is the n assigned out from the IS group. Given CORP’s disproportionate (2:1) usage of the services o f IS, this method then results in the highest overall allocat ion of costs to CORP. By contrast, GOVT’s usage of the AS group exceeds that of CORP (by a ratio of 8:7), and so GOVT is assigned relat ively more in support costs when AS costs are assigned second, after they have already been incremented by the AS share of IS costs as well. 15­6 3. Three criteria that could determine the sequence in the step­down method are: a. Allocate support departments on a ranking of the percentage of their total services provided to other support departments. 1. Administrative Services 25% 2. Informat ion Systems 10% b. Allocate support departments on a ranking of the total do llar amount in the support departments. 1. Informat ion Systems $2,400,000 2. Administrative Services $ 600,000 c. Allocate support departments on a ranking of the dollar amounts of service provided to other support departments 1. Informat ion Systems (0.10 ´ $2,400,000) = $240,000 2. Administrative Services (0.25 ´ $600,000) = $150,000 The approach in (a) above typically better approximates the theoretically preferred reciprocal method. It results in a higher percentage of support­department costs provided to other support departments being incorporated into the step­down process than does (b) or (c), above. 15­20 (50 min.) Support­department cost allocation, reciprocal method (continuation of 15­19). 1a. Support Departments AS I S $600,000 $2,400,000 (861,538) 261,538 $ 0 215,385 (2,615,385) $ 0 Operating Departments Govt. Corp. Costs Alloc. of AS costs (0.25, 0.40, 0.35) Alloc. of IS costs (0.10, 0.30, 0.60) $ 344,615 784,616 $1,129,231 $ 301,538 1,569,231 $1,870,769 Reciprocal Method Computation AS = $600,000 + 0.10 IS IS = $2,400,000 + 0.25AS IS = $2,400,000 + 0.25 ($600,000 + 0.10 IS) = $2,400,000 + $150,000 + 0.025 IS 0.975IS = $2,550,000 IS = $2,550,000 ÷ 0.975 = $2,615,385 AS = $600,000 + 0.10 ($2,615,385) = $600,000 + $261,538 = $861,538 15­7 1b. Support Departments AS I S $600,000 $2,400,000 (600,000) 150,000 2,550,000 (2,550,000) 63,750 (63,750) 1,594 (1,594) 40 (40) 1 (1) $ 0 Operating Departments Govt. Corp. Costs s 1 t Allocat ion of AS (0.25, 0.40, 0.35) s 1 t Allocat ion of IS (0.10, 0.30, 0.60) n 2 d Allocat ion of AS (0.25, 0.40, 0.35) n 2 d Allocat ion of IS (0.10, 0.30, 0.60) 3rd Allocat ion of AS (0.25, 0.40, 0.35) rd 3 Allocation of IS (0.10, 0.30, 0.60) th 4 Allo cation o f AS (0.25, 0.40, 0.35) th 4 Allo cation o f IS (0.10, 0.30, 0.60) th 5 Allo cation o f AS (0.25, 0.40, 0.35) th 5 Allo cation o f IS (0.10, 0.30, 0.60) Total allocat ion $ 240,000 $ 210,000 255,000 (255,000) 6,375 (6,375) 160 (160) 4 (4) 0 $ 0 765,000 102,000 19,125 2,550 478 64 12 2 0 $1,129,231 1,530,000 89,250 38,250 2,231 956 56 24 1 1 $1,870,769 2. a. b. c. d. e. Direct Step­Down (AS first) Step­Down (IS first) Reciprocal (linear equations) Reciprocal (repeated iterations) Govt. Consulting $1,120,000 1,090,000 1,168,000 1,129,231 1,129,231 Corp. Consulting $1,880,000 1,910,000 1,832,080 1,870,769 1,870,769 The four methods differ in the level o f support department cost allocat ion across support departments. The level o f reciprocal service by support departments is material. Administrative Services supplies 25% of its services to Informat ion Systems. Information Systems supplies 10% of its services to Administrative Services. The Informat ion Department has a budget of $2,400,000 that is 400% higher than Administrative Services. The reciprocal method recognizes all the interactions and is thus the most accurate. This is especially clear from looking at the repeated iterations calculat ions. 15­8 15­21 (40 min.) Direct and step­down allocation. 1. Support Departments HR Info. Systems $72,700 $234,400 (72,700) (234,400) $ 0 Operating Departments Corporate Consumer $ 998,270 $489,860 43,620 127,855 $1,169,745 29,080 106,545 $625,485 Total $1,795,230 Costs Incurred Alloc. of HR costs (42/70, 28/70) Alloc. of Info. Syst. costs (1,920/3,520, 1,600/3,520) $ 0 $1,795,230 2. Rank on percentage of services rendered to other support departments. Step 1: HR provides 23.077% of its services to informat ion systems: 21 21 = = 91 42 + 28 + 21 This 23.077% of $72,700 HR department costs is $16,777. Step 2: Informat ion systems provides 8.333% of its services to HR: 320 320 = = 8.333% 3 840 , 1 920 + 1 600 + 320 , , This 8.333% of $234,400 informat ion systems department costs is $19,533. Support Departments HR Info. Systems $72,700 $234,400 (72,700) $ 0 16,777 251,177 (251,177) $ 0 Operating Departments Corporate Consumer $ 998,270 $489,860 33,554 22,369 Total $1,795,230 23.077% Costs Incurred Alloc. of HR costs (21/91, 42/91, 28/91) Alloc. of Info. Syst. costs (1,920/3,520, 1,600/3,520) 137,006 $1,168,830 114,171 $626,400 $1,795,230 3. An alternat ive ranking is based on the dollar amount of services rendered to other support departments. Using numbers fro m requirement 2, this approach would use the fo llowing sequence: Step 1: Allocate Informat ion Systems first ($19,533 provided to HR). Step 2: Allocate HR second ($16,777 provided to Informat ion Systems). 15­9 15­22 (30 min.) Reciprocal cost allocation (continuation of 15­21). 1. The reciprocal allocat ion method explicit ly includes the mutual services provided amo ng all support departments. Interdepartmental relat ionships are fully incorporated into the support department cost allocat ions. 2. HR = $72,700 + .08333IS IS = $234,400 + .23077HR HR = $72,700 + [.08333($234,400 + .23077HR)] = $72,700 + [$19,532.55 + 0.01923HR] 0.98077HR = $92,232.55 HR = $92,232.55 ¸ 0.98077 = $94,041 IS = $234,400 + (0.23077 ´ $94,041) = $256,102 Support Depts. HR Info. Systems $72,700 $234,400 (94,041) 21,702 Operating Depts. Corporate Consumer Total $ 998,270 $489,860 $1,795,230 43,404 28,935 Costs Incurred Alloc. of HR costs (21/91, 42/91, 28/91) Alloc. of Info. Syst. costs (320/3,840, 1,920/3,840, 1,600/3,840) 21,341 $ 0 (256,102) $ 0 128,051 $1,169,725 106,710 $625,505 $1,795,230 Solution Exhibit 15­22 presents the reciprocal method using repeated iterations. 15­10 SOLUTION EXHIBIT 15­22 Reciprocal Method of Allocating Support Department Costs for September 2009 at E­books Using Repeated Iterations Support Departments Operating Departments Information Corporate Consumer Human Resources Systems Sales Sales Total Budgeted manufacturing overhead costs before any interdepartmental cost allocation st 1 Allocation of HR a (21/91, 42/91, 28/91) st 1 Allocation of Information Systems b (320/3,840, 1,920/3,840, 1,600/3,840) n 2 d Allocation of HR (21/91, 42/91, 28/91)a n 2 d Allocation of Information Systems b (320/3,840, 1,920/3,840, 1,600/3,840) r 3 d Allocation of HR (21/91, 42/91, 28/91)a r 3 d Allocation of Information Systems b (320/3,840, 1,920/3,840, 1,600/3,840) th 4 Allocation of HR (21/91, 42/91, 28/91)a th 4 Allocation of Information Systems: (320/3,840, 1,920/3,840, 1,600/3,840)b $72,700 (72,700) $234,400 16,777 251,177 $ 998,270 33,554 $489,860 22,369 $1,795,230 20,931 (20,931) 402 (402) (251,177) 4,830 (4,830) 93 125,589 9,661 2,415 185 104,657 6,440 2,013 124 8 (8) 0 $ 0 (93) 2 (2) $ 0 46 4 1 $1,169,725 39 2 1 $625,505 $1,795,230 Total budgeted manufacturing overhead of operating departments Total accounts allocated and reallocated (the numbers in parentheses in first two columns) HR $72,700 + $20,931 + $402 + $8 = $94,041 Information Systems $251,177 + $4,830 + $93 + $2 = $256,102 a b Base is (21 + 42 + 28) or 91 employees Base is (320 + 1,920 + 1,600) or 3,840 minutes 3. The reciprocal method is more accurate than the direct and step­down methods when there are reciprocal relat ionships amo ng support departments. A summary o f the alternat ives is: Direct method Step­down method (HR first) Reciproca l method Corporate Sales $1,169,745 1,168,830 1,169,725 Consumer Sales $625,485 626,400 625,505 The reciprocal method is the preferred method, although for September 2009 the numbers do not appear materially different across the alternatives. 15­11 15­23 1. (20-30 min.) Allocation of common costs. Three methods of allocating the $55 are: Stand­alone Incremental (Ed primary) Incremental (Mike pr imary) Shapley value a. Stand­alone cost allocat ion method. Mike: $40 $40 + $20 $20 $40 + $20 Mike $37 35 40 37.50 Ed $18 20 15 17.50 ´ $55 = 2 3 1 3 ´ $55 = $37 Ed: ´ $55 = ´ $55 = $18 b. Incremental cost allocat ion method. Assume Ed (the owner) is the pr imary user and Mike is the incremental user: User Ed Mike Total Costs Allocated $20 35 ($55 – $20) $55 Cumulative Costs Allocated $20 $55 This method may generate some dispute over the ranking. Notice that Mike pays only $35 despite his prime interest in the more expensive Internet access package. Ed could make the argument that if Mike were ranked first he would have to pay $40 since he is the major Internet user. Then, Ed would only have to pay $15! Assume Mike is the primary user and Ed is the incremental user: Costs Allocated $40 15 ($55 – $40) $55 Cumulative Costs Allocated $40 $55 User Mike Ed Total c. Shapley value (average over costs allocated as the primary and incremental user). Costs Allocated ($40 + $35) ¸ 2 = $37.50 ($20 + $15) ¸ 2 = $17.50 User Mike Ed 15­12 2. I would recommend the Shapley value. It is fairer than the incremental method because it avo ids considering one user as the primary user and allocat ing more of the co mmo n costs to that user. It also avoids disputes about who is the primary user. It allo cates costs in a manner that is close to the costs allocated under the stand­alone method but takes a more comprehensive view of the common cost allocat ion problem by considering primary and incremental users that the stand­alone method ignores. More generally, other criteria to guide commo n cost allocat ions include the fo llowing: a. Cause and effect. It is not possible to trace individual causes (either Internet access or phone services) to individual effects (uses by Mike or Ed). The $55 total package is a bundled product. b. Benefit s received. There are various ways o f operationalizing the benefits received: (i) Monthly service charge for their prime interest––Internet access for Mike ($40), and phone services for Ed ($20). This measure captures the services available to each person. (ii) Actual usage by each person. This would invo lve keeping a record of usage by each person and then allocat ing the $55 on a percent usage time basis. This measure captures the services actually used by each person, but it may prove burdenso me and it would be subject to honest reporting by Ed and Mike. c. Abilit y to pay. This criterion requires that Mike and Ed agree upon their relat ive abilit y to pay. d. Fairness or equit y. This criterion is relat ively nebulous. A straightforward approach would be to split the $55 equally amo ng the two users. 15­13 15­24 (20 min.) Allocation of common costs. 1. Alternat ive approaches for the allocation of the $1,800 airfare include the fo llowing: a. The stand­alo ne cost allocat ion method. This method would allocate the air fare on the basis o f each client’s percentage of the total of the individual stand­alo ne costs. Balt imore client Chicago client $1, 400 ´ $1,800 = $1,008 ( $1, 400 + $1,100 ) $1, 100 ´ $1,800 = ( $1, 400 + $1,100 ) 792 $1,800 Advocates of this method often emphasize an equity or fairness rationale. b. The incremental cost allocat ion method. This requires the cho ice o f a primary part y and an incremental part y. If the Balt imore client is the primary party, the allo cation would be: Balt imore client Chicago client $1,400 400 $1,800 One rat ionale is that Gunn was planning to make the Balt imore trip, and the Chicago stop was added subsequent ly. Some students have suggested allocating as much as possible to the Balt imore client since Gunn had decided not to work for them. If the Chicago client is the pr imary part y, the allocation would be: Chicago client Balt imore client $1,100 700 $1,800 One rationale is that the Chicago client is the one who is going to use Gunn’s services, and presumably receives more benefit s from the travel expenditures. c. Gunn could calculate the Shapley value that considers each client in turn as the primary part y: The Balt imore client is allo cated $1,400 as the primary party and $700 as the incremental party for an average of ($1,400 + $700) ÷ 2 = $1,050. The Chicago client is allocated $1,100 as the primary part y and $400 as the incremental party for an average of ($1,100 + 400) ÷ 2 = $750. The Shapley value approach would allocate $1,050 to the Balt imore client and $750 to the Chicago client. 15­14 2. I would recommend Gunn use the Shapley value. It is fairer than the incremental method because it avoids considering one party as the primary part y and allocat ing more of the commo n costs to that party. It also avo ids disputes about who is the primary party. It allocates costs in a manner that is close to the costs allocated under the stand­alone method but takes a more comprehensive view o f the commo n cost allocation problem by considering primary and incremental users, which the stand­alo ne method ignores. The Shapley value (or the stand­alone cost allocation method) would be the preferred methods if Gunn was to send the travel expenses to the Balt imore and Chicago clients before deciding which engagement to accept. Other factors such as whether to charge the Chicago client more because Gunn is accepting the Chicago engagement or the Balt imore client more because Gunn is not going to work for them can be considered if Gunn sends in her travel expenses after making her decisio n. However, each co mpany would not want to be considered as the primar y party and so is likely to object to these arguments. 3. A simple approach is to split the $60 equally between the two clients. The limousine costs at the Sacramento end are not a funct ion of distance traveled on the plane. An alternative approach is to add the $60 to the $1,800 and repeat requirement 1: a. Stand­alone cost allo cat ion method. $1, 460 Balt imore client ´ $1,860 = $1,036 ( $1, 460 + $1,160 ) Chicago client $1, 160 ´ $1,860 = $ 824 ( $1, 460 + $1,160 ) b. Incremental cost allocation method. Wit h Balt imore client as the primary part y: Balt imore client $1,460 Chicago client 400 $1,860 Wit h Chicago client as the primary party: Chicago client $1,160 Balt imore client 700 $1,860 c. Shapley value. Balt imore client: Chicago client: ($1,460 + $700) ÷ 2 = $1,080 ($400 + $1,160) ÷ 2 = $ 780 As discussed in requirement 2, the Shapley value or the stand­alone cost allocat ion method would probably be the preferred approaches. Note: If any students in the class have faced this situation when vis it ing prospective emplo yers, ask them how they handled it. 15­15 15­25 (20 min.) Revenue allocation, bundled products. 1a. Under the stand alo ne revenue­allocat ion method based on selling price, Monaco will be allocated 40% of all revenues, or $72 of the bundled selling price, and Innocence will be allocated 60% of all revenues, or $108 of the bundled selling price, as shown below. Stand­alone method, based on selling prices Monaco Innocence Selling price $80 $120 Selling price as a % of total ($80 ¸ $200; $120 ¸ $200) 40% 60% Allocat ion of $180 bundled selling price $72 $108 (40% ´ $180; 60% ´ $180) Total $200 100% $180 1b. Under the incremental revenue­allocat ion method, with Monaco ranked as the primar y product, Monaco will be allocated $80 (its own stand­alo ne selling price) and Innocence will be allocated $100 of the $180 selling price, as shown below. Incremental Method (Monaco rank 1) Selling price Allocat ion of $180 bundled selling price ($80; $100 = $180 – $80) Monaco Innocence $80 $120 $80 $100 1c. Under the incremental revenue­allo cat ion method, with Innocence ranked as the primar y product, Innocence will be allocated $120 (its own stand­alone selling price) and Monaco will be allocated $60 of the $180 selling price, as shown below. Incremental Method (Innocence rank 1) Selling price Allocat ion of $180 bundled selling price ($60 = $180 – $120; $120) Monaco Innocence $80 $120 $60 $120 1d. Under the Shapley value method, each product will be allo cated the average of its allocat ions in 1b and 1c, i.e., the average o f its allocat ions when it is the primary product and when it is the secondary product, as shown below. Shapley Value Method Allocat ion when Monaco = Rank 1; Innocence = Rank 2 (fro m 1b.) Allocat ion when Innocence = Rank 1; Monaco = Rank 2 (from 1c.) Average of allocated selling price ($80 + $60) ¸ 2; ($100 + $120) ¸ 2 Monaco Innocence $80 $60 $70 $100 $120 $110 15­16 2. A summary o f the allocat ions based on the four methods in requirement 1 is shown below. Incremental (Monaco first) $ 80 100 $180 Incremental (Innocence first) $ 60 120 $180 Stand­alone (Selling Prices) Monaco $ 72 Innocence 108 Total for L’Amour $180 Shapley $ 70 110 $180 If there is no clear indicat ion of which product is the more “important” product, or, if it can be reasonably assumed that the two products are equally important to the company's strategy, the Shapley value method is the fairest of all the methods because it averages the effect of product rank. In this particular case, note that the allocations fro m the stand­alo ne method based on selling price are reasonably similar to the allocations fro m the Shapley value method, so the managers at Yves may well want to use the much simpler stand­alo ne method. The stand­alone method also does not require ranking the products in the suite, and so it is less likely to cause debates among product managers in the Men's and Wo men's Fragrance divisio ns. If, however, one of the products (Monaco or Innocence) is clearly the product that is driving sales of the bundled product, then that product should be considered as the primary product. 15­26 (10­15 min. ) Allocation of Common Costs 1. a. Stand­alone method (costs are in thousands): Separate City Cost Albany $2,100 Troy 1,400 Schenectady 3,500 $7,000 Joint Percentage Cost $2,100 ÷ $7,000=0.3 $5,000 $1,400 ÷ $7,000=0.2 5,000 $3,500 ÷ $7,000=0.5 5,000 Allocation $1,500 1,000 2,500 $5,000 1. b. Incremental method (cit ies ranked in order of most waste to least waste): Allocated Cost $3,500 1,500 0 Cost Remaining to Allocate $1,500 ($5,000 ─ $3,500) 0 ($1,500 ─ $1,500) 0 Schenectady Albany Troy 2. In this situat ion, the stand­alone method is the better method because the weights it uses for allocat ion are based on the cost for each user as a separate entit y. The cit izens of Schenectady would not consider the incremental method fair because they would be subsidizing the other cit ies (especially Troy). Albany is indifferent across the two methods; its cit izens save $600,000 over the stand­alone cost in either case. While the cit izens of Troy would clearly prefer the incremental allocat ion method and might seek to justify it because they generate the least amount of waste, they should understand that cit izens o f the other cit ies would believe it is not fair. 15­17 15­27 (20 min.) Single­rate, dual­rate, and practical capacity allocation. Budgeted number of gifts wrapped = 6,750 Budgeted fixed costs = $6,750 Fixed cost per gift based on budgeted volume = $6,750 ÷ 6,750 = $1.00 Average budgeted variable cost per gift = 0.50 Total cost per gift wrapped $1.50 1.a. Allocat ion based on budgeted usage of gift­wrapping services: $ 3,712.50 1,237.50 2,700.00 675.00 1,800.00 $10,125.00 Wo men’s Face Wash (2,475 × $1.50) Men’s Face Wash (825 × $1.50) Fragrances (1,800 × $1.50) Body Wash (450 × $1.50) Hair Products (1,200 × $1.50) Total 1.b. Allocat ion based on actual usage of gift­wrapping services: Wo men’s Face Wash (2,100 × $1.50) Men’s Face Wash (750 × $1.50) Fragrances (1,575 × $1.50) Body Wash (525 × $1.50) Hair Products (1,050 × $1.50) Total 1.c. $3,150.00 1,125.00 2,362.50 787.50 1,575.00 $9,000.00 Practical gift­wrapping capacit y = 7,500 Budgeted fixed costs = $6,750 Fixed cost per gift based on practical capacit y = $6,750 ÷ 7,500 = Average budgeted variable cost per gift = Total cost per gift wrapped Allocat ion based on actual usage of gift­wrapping services: Wo men’s Face Wash (2,100 × $1.40) Men’s Face Wash (750 × $1.40) Fragrances (1,575 × $1.40) Body Wash (525 × $1.40) Hair Products (1,050 × $1.40) Total $2,940 1,050 2,205 735 1,470 $8,400 $0.90 0.50 $1.40 15­18 2. Budgeted rate for fixed costs = Budgeted fixed costs Practical capacity =$6,750 ÷ 7,500 gifts = $0.90 per gift Fixed costs allocated on budgeted usage. Rate for variable costs = $0.50 per item Variable costs based on actual usage. Allocat ion: Department Wo men’s Face Wash Men’s Face Wash Fragrances Body Wash Hair Products Total 3. Variable Costs Fixed Costs 2,100 × $0.50 =$1,050.00 2,475 × $0.90 = $2,227.50 750 × $0.50 = 375.00 825 × $0.90 = 742.50 1,575 × $0.50 = 787.50 1,800 × $0.90 = 1,620.00 525 × $0.50 = 262.50 450 × $0.90 = 405.00 1,050 × $0.50 = 525.00 1,200 × $0.90 = 1,080.00 $3,000.00 $6,075.00 Total $3,277.50 1,117.50 2,407.50 667.50 1,605.00 $9,075.00 The dual­rate method has two major advantages over the single­rate method: a. Fixed costs and variable costs can be allocated different ly—fixed costs based on rates calculated using pract ical capacit y and budgeted usage and variable costs based on budgeted rates and actual usage. b. Fixed costs are allocated proportionately to the departments causing the incurrence o f those costs based on the capacit y o f each department. c. The costs allocated to a department are not affected by the usage by other departments. Note: If capacit y costs are the result of a long­term decisio n by top management, it may be desirable to allocate to each department the cost of capacit y used based on actual usage. The users are then not allocated the costs of unused capacit y. 15­19 15­28 (20 min.) Revenue allocation 1. a. Stand­alone method for the BegM + RCC package Separate Revenue $ 60 40 $100 Joint Percentage Revenue $60 ÷ $100=0.6 $90 $40 ÷ $100=0.4 90 DVD BegM RCC Allocation $54 36 $90 1. b. Incremental method i) BegM RCC ii) RCC BegM Allocated Revenue (BegM first) $60 30 Allocated Revenue (RCC first) $40 50 Revenue Remaining To Allocate $30 ($90 ─ $60) Revenue Remaining To Allocate $50 ($90 ─ $40) 1. c. Shapley method. (assuming each DVD is demanded in equal proportion) i) BegM ii) RCC ($60 + $50) ÷ 2 = $55 ($30 + $40) ÷ 2 = $35 2. a. Stand­alone method for the ConM + RCC package Separate Revenue $50 40 $90 Joint Percentage Revenue $50 ÷ $90=0.556 $72 $40 ÷ $90=0.444 72 DVD ConM RCC Allocation $40 32 $72 2. b. Incremental method i) Allocated Revenue (ConM first) $50 22 Allocated Revenue (RCC first) $40 32 Revenue Remaining To Allocate $22 ($72 ─ $50) ConM RCC ii) RCC ConM Revenue Remaining To Allocate $32 ($72 ─ $40) 15­20 2. c. Shapley method. (assuming each DVD is demanded in equal proportion) i) BegM ii) RCC (50+32) ÷ 2 = 41 (22+40) ÷ 2 = 31 3. For each DVD package, the stand­alone method and the Shapley method give approximately the same allocat ion to each DVD. These methods are fair if the demand for the DVDs are approximately equal. The stand­alo ne method might be slight ly preferable here since it is simpler and easier to explain. The incremental method would be appropriate if one DVD has a higher level o f demand than the other DVD. In this situat ion, the dominant DVD would be so ld anyway so it should receive its stand­alo ne revenue, and the other DVD should receive the remainder. 15­21 15­29 (20 min.) Fixed cost allocation 1. i) Allocat ion using actual usage. Actual Usage 1,500 1,400 1,300 4,200 Percentage of Total Usage 0.357 0.333 0.310 Allocation % × 10,000 $ 3,570 3,330 3,100 $10,000 Restaurant A B C Total ii) Allo cat ion using planned usage. Percentage of Total Planned Usage 0.400 0.325 0.275 Restaurant A B C Total Planned Usage 1,600 1,300 1,100 4,000 Allocation % × 10,000 $ 4,000 3,250 2,750 $10,000 iii) Allocat ion using practical capacit y. Percentage of Total Practical Capacity 0.400 0.300 0.300 Restaurant A B C Total Practical Capacity 2,000 1,500 1,500 5,000 Allocation % × 10,000 $ 4,000 3,000 3,000 $10,000 2. If the practical capacit y refers to the number of parking spots that are earmarked or reserved for each of the restaurants, then it would appear to be the most appropriate basis for allocat ing the $10,000 commo n cost. This ratio is a stable benchmark and does not fluctuate based on variat ions in either the actual or planned monthly usage of spots for each of the restaurants, which is an issue wit h each o f the other two methods. Moreover, the practical capacit y taken by eac h restaurant presumably reflects the restaurant’s expectation of the long­run usage of the parking facilit y by its patrons. The cost of any unused capacit y then highlights the extent to which these expectations are not met, and might lead to the restaurant settling for a smaller parking facilit y in the future. Of course, if it is ever the case that the expected or actual usage for any restaurant exceeds the pract ical capacit y that it has “booked,” it would need to suitably co mpensate the other restaurants for the portion of their parking capacit y it has appropriated. 15­22 15­30 (45 min.) Allocating costs of support departments; step­down and direct methods. Building & Grounds $ 10,000 $(10,000) General Plant Admin. $ 26,090 700 210 $(27,000) Cafeteria Operating Loss $ 1,640 400 60 1,000 $(3,100) 1. Step­down Method: (1) Building & grounds at $0.10/sq.ft. ($10,000 ÷ 100,000) (2) Personnel at $6/employee ($1,200 ÷ 200) (3) General plant administration at $1/labor­hour ($27,000 ÷ 27,000) (4) Cafeteria at $20/empoloyee ($3,100 ÷ 155) (5) Storeroom at $1.50/requisition ($4,500 ÷ 3,000) (6) Costs allocated to operating depts. (7) Divide (6) by dir. manuf. labor­hrs. (8) Overhead rate per direct manuf. labor­hour 2. Direct method: (1) Building & grounds, 30,000/80,000; 50,000/80,000 (2) Personnel, 50/150; 100/150 (3) General plant administration, 8,000/25,000; 17,000/25,000 (4) Cafeteria, 50/150; 100/150 (5) Storeroom: 2,000/3,000; 1,000/3,000 (6) Costs allocated to operating depts. (7) Divide (6) by direct manufacturing labor­hours (8) Overhead rate per direct manufacturing labor­hour Personnel $ 1,000 200 $(1,200) Storeroom $ 2,670 700 30 1,000 100 $(4,500) Machining $34,700 3,000 300 8,000 1,000 3,000 $50,000 ÷ 5,000 $ 10 Assembly $48,900 5,000 600 17,000 2,000 1,500 $75,000 ÷15,000 $ 5 $48,900 6,250 667 17,741 1,093 890 $75,541 ÷15,000 $ 5.036 $10,000 (10,000) $1,000 $26,090 $1,640 $2,670 $34,700 3,750 333 (1,000) (26,090) (1,640) (2,670) 8,349 547 1,780 $49,459 ÷ 5,000 $ 9.892 15­23 3. Comparison o f Methods: 18 × $10 2 × $ 5 3 × $10 17 × $ 5 18 × $9.892 2 × $5.036 3 × $9.892 17 × $5.036 $180 10 $ 30 85 $178.06 10.07 $ 29.68 85.61 Step­down method: Job 88: Job 89: $190.00 115.00 Direct method: Job 88: Job 89: $188.13 115.29 4. The manager of Machining Depart ment would prefer the direct method. The direct method results in a lower amount of support departments’ costs being allo cated to the Machining Department than the step­down method. This is clear fro m a co mparison o f the overhead rate, per direct manufacturing labor­hour, for the Machining Department under the two methods. 15­24 15­31 (40–60 min.) Support­department cost allocations; single­department cost pools; direct, step­down, and reciprocal methods. All the fo llo wing co mputations are in do llars. 1. Direct method: To X To Y A 250/400 ´ $100,000 = $62,500 150/400 ´ $100,000 = $37,500 B 100/500 ´ $ 40,000 = 8,000 400/500 ´ $ 40,000 = 32,000 Total $70,500 $69,500 Step­down method, allocat ing A first: Costs to be allocated Allocate A: (100; 250; 150 ÷ 500) Allocate B: (100; 400 ÷ 500) Total Step­down method, allocat ing B first: A Costs to be allocated $100,000 Allocate B: (500; 100; 400 ÷ 1,000) 20,000 Allocate A: (250/400, 150/400) (120,000) Total $ 0 B $ 40,000 (40,000) — $ 0 X — $ 4,000 75,000 $79,000 Y — $16,000 45,000 $61,000 A $100,000 (100,000) — $ 0 B $40,000 20,000 (60,000) $ 0 X — $50,000 12,000 $62,000 Y — $30,000 48,000 $78,000 Note that these methods produce significant ly different results, so the cho ice of method may frequently make a difference in the budgeted department overhead rates. Reciprocal method: Stage 1: Let (1) (2) A B A B = = = = total costs of materials­handling department total costs of power­generating department $100,000 + 0.5B $ 40,000 + 0.2A A A 0.9A A = = = = $100,000 + 0.5($40,000 + 0.2A) $100,000 + $20,000 + 0.1A $120,000 $133,333 Stage 2: Substituting in (1): Subst ituting in (2): B = $40,000 + 0.2($133,333) B = $66,666 Stage 3: Original amounts Allocat ion of A Allocat ion of B Totals accounted for A $100,000 (133,333) 33,333(50%) $ 0 B X Y $40,000 — — 26,666(20%) $66,667(50%) $40,000(30%) (66,666) 6,667(10%) 26,666(40%) $ 0 $73,334 $66,666 15­25 SOLUTION EXHIBIT 15­31 Reciprocal Method of Allocating Support Department Costs for Manes Company Using Repeated Iterations. Operating Departments X Y $50,000 $30,000 Support Departments A B Budgeted manufacturing overhead costs before any interdepartmental cost allocations st 1 Allocation of Dept. A: (2/10, 5/10, 3/10)a st 1 Allocation of Dept. B (5/10, 1/10, 4/10)b n 2 d Allocation of Dept. A (2/10, 5/10, 3/10)a n 2 d Allocation of Dept B: (5/10, 1/10, 4/10)b r 3 d Allocation of Dept A: (2/10, 5/10, 3/10)a r 3 d Allocation of Dept. B: (5/10, 1/10, 4/10)b th 4 Allocation of Dept. A (2/10, 5/10, 3/10)a th 4 Allocation of Dept. B (5/10, 1/10, 4/10)b th 5 Allocation of Dept A (2/10, 5/10, 3/10) th 5 Allocation of Dept B (5/10, 1/10, 4/10) th 6 Allocation of Dept A (2/10, 5/10, 3/10) Total budgeted manufacturing overhead of operating departments $100,000 (100,000) $40,000 20 000 , 60 000 , (60,000) 6,000 (6,000) 600 (600) 60 (60) 6 (6) 0 $ 0 30,000 (30,000) 3,000 (3,000) 300 (300) 30 (30) 3 (3) $ 0 6,000 15,000 600 1,500 60 150 6 15 1 2 $73,334 24,000 9,000 2,400 900 240 90 24 9 2 1 $66,666 Total accounts allocated and reallocated (the numbers in parentheses in first two columns) Dept A; Materials Handling: $100,000 + $30,000 + $3,000 + $300 + $30 + $3 = $133,333 Dept B; Power Generation: $60,000 + $6,000 + $600 + $60 + $6 = $66,666 a b Base is (100 + 250 +150) or 500 labor­hours; 100 ÷ 500 = 2/10, 250 ÷ 500 = 5/10, 150 ÷ 500 = 3/10. Base is (500 + 100 + 400) or 1,000 kWh ; 500 ÷ 1,000 = 5/10, 100 ÷ 1,000 = 1/10, 400 ÷ 1,000 = 4/10. Comparison o f methods: Method of Allocation Direct method Step­down: A first Step­down: B first Reciprocal method X $70,500 62,000 79,000 73,334 Y $69,500 78,000 61,000 66,666 Note that in this case the direct method produces answers that are the closest to the “correct” answers (that is, those from the reciprocal method), step­down allocat ing B first is next, and step­ down allocat ing A first is least accurate. 15­26 2. At first glance, it appears that the cost of power is $40 per unit plus the material handling costs. If so, Manes would be better off by purchasing fro m the power company. However, the decision should be influenced by the effects of the interdependencies and the fixed costs. Note that the power needs would be less (students frequently miss this) if they were purchased from the outside: Outside Power Units Needed 100 400 X Y A (500 units minus 20% of 500 units, because there is no need to service the nonexistent power department) Total units Total costs, 900 ´ $40 = $36,000 400 900 In contrast, the total costs that would be saved by not producing the power inside would depend on the effects of the decisio n on various costs: Avoidable Costs of 1,000 Units of Power Produced Inside Variable indirect labor and indirect material costs Supervisio n in power department Materials handling, 20% of $70,000* Probable minimum cost savings Possible addit ional savings: a. Can any supervisio n in materials handling be saved because of overseeing less vo lume? Minimum savings is probably zero; the maximum is probably 20% of $10,000 or $2,000. b. Is any depreciation a truly variable, wear­and­tear type of cost? Total savings by not producing 1,000 units of power * Materials handling costs are higher because the power department uses 20% of materials handling. Therefore, materials­handling costs will decrease by 20%. $10,000 10,000 14,000 $34,000 ? ? ______ $34,000 + ? In the short run (at least until a capital invest ment in equipment is necessary), the data suggest continuing to produce internally because the costs eliminated would probably be less than the comparable purchase costs. 15­27 15­32 (25 min.) Common costs. 1. Stand­alone cost­allocat ion method. Wright, Inc. = (900 ´ $40) ´ (1, 500 ´ $32) (900 ´ $40) + (600 ´ $40) $36, 000 ´ $48, 000 = $28,800 ($36, 000 + $24, 000) (600 ´ $40) ´ (1, 500 ´ $32) (900 ´ $40) + (600 ´ $40) $24, 000 ´ $48, 000 = $19,200 ($36, 000 + $24, 000) = Brown, Inc. = = 2. Wit h Wright, Inc. as the primary party: Party Wright Brown Total Costs Allocated $36,000 12,000 ($48,000 – $36,000) $48,000 Cumulative Costs Allocated $36,000 $48,000 Wit h Brown, Inc. as the pr imary part y: Party Brown Wright Total Costs Allocated $24,000 24,000 ($48,000 – $24,000) $48,000 Cumulative Costs Allocated $24,000 $48,000 15­28 3. To use the Shapley value method, consider each party as first the primary part y and then the incremental party. Compute the average of the two to determine the allocat ion. Wright, Inc.: Allocat ion as the pr imary part y Allocat ion as the incremental part y Total Allocat ion ($60,000 ÷ 2) Brown, Inc.: Allocat ion as the primary part y Allocat ion as the incremental part y Total Allocat ion ($36,000 ÷ 2) $36,000 24,000 $60,000 $30,000 $24,000 12,000 $36,000 $18,000 Using this approach, Wright, Inc. is allocated $30,000 and Brown, Inc. is allocated $18,000 of the total costs of $48,000. 4. The results of the four cost­allocat ion methods are shown below. Wright, Inc. $28,800 36,000 24,000 30,000 Brown, Inc. $19,200 12,000 24,000 18,000 Stand­alone method Incremental (Wright primary) Incremental (Brown primary) Shapley value The allocat ions are very sensit ive to the method used. The stand­alone method is simple and fair since it allo cates the commo n cost of the dyeing machine in proportion to the individual costs of leasing the machine. The Shapley values are also fair. They result in very similar allocat ions and any one of them can be chosen. In this case, the stand­alone method is likely more acceptable. If they used the incremental cost­allocat ion method, Wright, Inc. and Brown, Inc. would probably have disputes over who is the primary part y because the primary part y gets allocated all o f the pr imary part y’s costs. 15­29 15­33 (20­25 mins.) Stand alone revenue allocation 1. Allocat ion using ticket sales price Percentage of Total Price 0.333 0.500 0.167 Allocation % × $90 $30 45 15 $90 Park Water Superhero Theme Animal Total Ticket Price $ 40 60 20 $120 2. Allocat ion using cost per entrant Cost Per Entrant $15 25 10 $50 Percentage of Total Cost 0.300 0.500 0.200 Allocation % × $90 $27 45 18 $90 Park Water Superhero Theme Animal Total 3. Allocat ion using # of tickets received # of Tickets Received 1 1 1 3 Percentage of Total Price 0.333 0.333 0.333 Allocation % × $90 $30 30 30 $90 Park Water Superhero Theme Animal Total 4. Sharing on the basis of revenue makes the most sense, especially if the ticket price is somewhat a surrogate for demand. One could argue that since each ticket gives the entrant one full day in each park, then an entrant’s willingness to pay more for a particular park reflects the addit ional value placed on that park. Also, it would be hard to just ify the Animal park receiving almost its full ticket price using the cost basis and more than its ticket price using the # of tickets basis. 15­30 15­34 (10­15 min.) Effect of demand (continuation of 15­33) 1. If the Water park receives its full t icket price of $40, then the remaining proceeds fro m the sale of the three day ticket, $90 – 40 = $50, would be divided between the two remaining parks. Using ticket price as the basis o f allocat ion, each park would receive: Percentage of Total Price 0.750 0.250 Allocation % × $50 $37.50 12.50 $50.00 Park Superhero Theme Animal Total Ticket Price $60 20 $80 The same process would be used for the other two allocat ion bases. Under the cost basis, the 25 Superhero Theme park receives ×$50 = $35.71, while Animal park gets the other $14.29. 25+10 If revenue is assigned based on the number of tickets received, then the Superhero Theme and Animal Parks would each receive $25. 2. If the Superhero Theme park also demanded its full t icket price then it would want to receive $60. The two parks, Water and Superhero Theme, would then receive a combined amount of $40 + 60 = $100. Since the three­day t icket sells for only $90, this would not be possible. In addition, the Animal park director would not be pleased because he would incur a $10 cost for each entrant but receive no proceeds from the ticket. 3. If both the Water and the Superhero Theme parks are really operating at capacit y then Funland is losing mo ney by selling the three­day ticket for $90. Kent Clark should either raise the price or decide not to sell the three­day ticket. Alternat ively, if he wishes to persist with the current arrangement, he should use a more sophist icated arrangement for allocating revenue, such as the Shapley method or even the weighted Shapley method. In the latter case, Kent could assign the number of months each park is considered the primary park as the weight ing scheme. For example, while the Water Park may drive sales of the three­day ticket during summer mo nths, customers may be more interested in one of the other parks during cooler periods. 15­31 Collaborative Learning Problem 15­35 (20–25 min.) Revenue allocation, bundled products. 1.a. The stand­alone revenues (using unit selling prices) of the three components of the $1,000 package are: Lodging $400.00 × 2 = $ 800 Recreat ion $187.50 × 2 = 375 Food $100.00 × 2 = 200 $1,375 Lodging $800 ´ $1, 000 = 0.582 ´ $1, 000 = $582 $1, 375 $375 ´ $1, 000 = 0.273 ´ $1, 000 = $273 $1, 375 $200 ´ $1, 000 = 0.145 ´ $1, 000 = $145 $1, 375 Recreat ion Food b. Product Recreat ion Lodging Food Revenue Allocated $ 375 625 ($1,000 – $375) 0 $1,000 Cumulative Revenue Allocated $ 375 $1,000 $1,000 15­32 2. The pros of the stand­alone­revenue­allocat ion method include the fo llowing: a. Each item in the bundle receives a posit ive weight, which means the result ing allocat ions are more likely to be accepted by all parties than a method allocat ing zero revenues to one or more products. b. It uses market­based evidence (unit selling prices) to decide the revenue allo cat ions— unit prices are one indicator of benefits received . c. It is simple to implement. The cons of the stand­alone revenue­allocat ion method include: a. It ignores the relat ive importance of the individual components in attracting consumers to purchase the bundle. b. It ignores the opportunity cost of the individual components in the bundle. The golf course operates at 100% capacit y. Getaway participants must reserve a golf booking one week in advance, or else they are not guaranteed playing time. A getaway participant who does not use the golf option may not displace anyo ne. Thus, under the stand­alone method, the golf course may be paid twice—once fro m the non­getaway person who does play and second from an allocatio n of the $1,000 package amount for the getaway person who does not play (eit her did not want to play or wanted to play but made a booking too late, or failed to show). c. The weight can be artificially inflated by individual product managers setting “high” list unit prices and then being willing to frequent ly discount these prices. The use o f actual unit prices or actual revenues per product in the stand­alo ne formula will reduce this problem. d. The weights may change frequently if unit prices are constant ly changing. This is not so much a crit icism as a reflect ion that the marketplace may be highly co mpet itive. The pros of the incremental method include: a. It has the potential to reflect that some products in the bundle are more highly valued than others. Not all products in the bundle have a similar “write­down” fro m unit list prices. Ensuring this “potential pro” becomes an “actual pro” requires that the cho ice of the primary product be guided by reliable evidence on consumer preferences. This is not an easy task. b. Once the sequence is chosen, it is straight forward to implement. The cons of the incremental method include: a. Obtaining the rankings can be highly contentious and place managers in a “no­win” acrimo nious debate. The revenue allocat ions can be sensit ive to the chosen rankings. b. Some products will have zero revenues assigned to them. Consider the Food divisio n. It would incur the costs for the two dinners but receive no revenue. 15­33 ...
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This note was uploaded on 10/11/2010 for the course ACCT 321 taught by Professor Cole during the Spring '10 term at University of Miami.

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