allocate single cost pool to users 1. have you ever been here? 2

Allocate Single Cost Pool to Users*

Dale R. Geiger 2011

Have you ever been here?*

Terminal Learning ObjectiveTask: Allocate Single Cost Pool to UsersCondition: You are training to become an ACE with access to ICAM course handouts, readings, and spreadsheet tools and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actorsStandard: with at least 80% accuracyExplain how poor cost information encourages undesired behaviorsCalculate driver rateCalculate proportion*

A Broad Definition of Managerial Costingmanagerial costingtranslationmanagerially useful information*

Why Is This Translation Needed?Accounting Systems usually measure input or source costsLabor, overhead, materialsSalaries, benefits, supplies, contractsManagers want measurements based on output or consumption Product, service, projectConsuming organization, customer*

Managerial Costing Termsraw accounting datamanagerial costingtranslationmanagerially useful information=cost pool method ofdistribution*

TerminologyCost pool: An aggregation of incurred or source costs to be distributedExamples:Salary and benefits, supplies, travel, etc. in an airfield operations centerUtility bills for a garrisoncost pool *

TerminologyMethod of distribution:The mechanics of deriving management information from the cost pool Example:Determine unit cost by adding all input costs and dividing by number of unitsmethod ofdistribution*

TerminologyCost Object: A view of cost needed by management Examples:120mm tube product costMorale, welfare, recreation costArmor school cost*

What is Allocation?Allocation: A method of distribution that distributes cost pool to cost objects in the same proportion as cost driverExample:Distributing the cost of utilities to occupants in the same proportion as space occupiedallocation based oncost driver*

The Mechanics of AllocationAllocation is a basic technique of activity based costing (ABC)Becoming an expert is required but easyAllocation mechanics excel spreadsheet makes it even easierallocation based oncost driver*

Dale R. Geiger 2011

Two Allocation MethodsRate Method: Uses a computed rate per driver unitProportion Method: Computes a proportional share of the total cost based on driver usageBoth MethodsYield same resultsRepresent the same underlying algebra *

Reconciling the Two MethodsEqualsEqualsProportionMethod*

Reconciling the Two MethodsEqualsEqualsRate Method*

Split the Dinner CheckThank YouFillet and Lobster 35.00Chicken Kiev 15.00Top Sirloin 20.00Caesar Salad 9.00Coffee 2 @1.00 2.00House Wine 4 @5.00 20.00Champagne 24.00Ice Cream 4.00Chocolate Cheesecake 6.00Sampler 10.00Soup/Salad 8.00Aperitif 7 .00

Total $160.00Chez ParisBobCarolTedAlice*

Identifying Key InformationWhat is the cost pool?The dinner check of $160What are the cost objects?Bob, Carol, Ted and AliceWhat is the cost driver?Number of persons (or eaters)*

Allocation Mechanics .xls*

Introduction

Welcome to the Allocation Mechanics Spreadsheet

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Objective:

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Methodology:

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Terminology:

Cost Pool:An aggregation of incurred or source costs to be distributed.

Cost Object:A view of cost needed by management.This can be a

department, process, unit, or any other relevant object.

Cost Driver:A basis for allocating the Cost Pool. The Cost Driver should

reflect the actual consumption of the Cost Pool resources.

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Many people are intimidated by calculations and accounting theory. The objective of this exercise is to illustrate the concept of allocation and demonstrate the simplicity of the actual calculation.

This worksheet is designed to work with Excel 97. Calculations are embedded in the worksheet, but you will need to enter information in the blank white cells. All other cells contain formulae and are locked. You can use the arrow keys to move between cells, and the tabs at the bottom of the screen to move between pages. If you need information about a step, help is available by pointing to the "Question Mark" boxes throughout the worksheet. If the Help balloons are visible now, go to the "View" Menu on the main toolbar and deselect "Comments"

The worksheet presents two allocation methods: the Rate Method and the Percentage Method. Both methods will yield the same allocation result, as they are merely two different ways of looking at the same calculation. However, you may find that one of the methods makes more sense or better illustrates the process for you.

Help Balloons will pop up when you point to the red question mark boxes.

Scroll Down for more information. Click the "Enter Data" Tab to start.


This is the end of the Introduction section. To begin, click on the "Enter Data" tab at the bottom of the screen.

Enter Data

Enter the Name of the Cost Pool to be Allocated here:

dinner check0

Enter the Total Cost ofdinner checkhere:

$160

Enter the Names of the Cost Objects here:

BobTedCarolAlice0?

Enter the Name of the Cost Driver here:

eaters0

&A

Page &P

Click in the white cells and enter the required information.

Driver Usage

Enter the Driver Usage by Cost Object here:

BobTedCarolAliceTotal

eaters11114

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&A

Page &P

Click in the white cells and enter amount of Cost Driver consumed by each Cost Object

Rate Method

Rate Method of Allocation

1. Determine Overhead Rate:

Total CostTotaleaters=Rate pereaters

$1604=$40

2. Compute Allocation:

Usage by Cost ObjectxRate=Allocation

Bob1x$40=$40

Ted1x$40=$40

Carol1x$40=$40

Alice1x$40=$40

Total$160

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&A

Page &P

Note that the entire Cost Pool has been allocated

Proportion Method

Proportion Method of Allocation:

1. Determine Proportion of Consumption

Usage by Cost ObjectTotaleaters=%

Bob14=25%

Ted14=25%

Carol14=25%

Alice14=25%

Total100%

2. Multiply Proportion by Total Cost

Cost Object %xTotaldinner check=Allocation

Bob25%x160=$40

Ted25%x160=$40

Carol25%x160=$40

Alice25%x160=$40

Total$160

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&A

Page &P


Graph

Cost Allocation fordinner checkBased oneaters

Graph

0000

Dept. A

Dept. B

Dept. C

Dept. D

Print Range




$1604=$40



Bob1x$40=$40

Ted1x$40=$40

Carol1x$40=$40

Alice1x$40=$40

Total$160




Bob14=25%

Ted14=25%

Carol14=25%

Alice14=25%

Total100%



Bob25%x160=$40

Ted25%x160=$40

Carol25%x160=$40

Alice25%x160=$40

Total$160


Print Range

0000

Dept. A

Dept. B

Dept. C

Dept. D

MBD000000F0.unknown

MBD00000370.unknown

MBD000004B0.unknown

MBD00000550.unknown

MBD00107B38.unknown

MBD001004EA.unknown

MBD00000500.unknown

MBD00000410.unknown

MBD00000460.unknown

MBD000003C0.unknown

MBD00000230.unknown

MBD000002D0.unknown

MBD00000320.unknown

MBD00000280.unknown

MBD00000190.unknown

MBD000001E0.unknown

MBD00000140.unknown

MBD00000050.unknown

MBD000000A0.unknown

Allocation by Rate MethodFirst, calculate the driver rate:Total cost poolTotal driver units

Cost pool = $160Total driver units = 4 eaters

Rate = $40/eater*

Allocation by Rate MethodSecond, multiply by driver units used by each cost object:Bob= 1 eater * $40/eater = $40Carol = 1 eater * $40/eater = $40Ted = 1 eater * $40/eater = $40Alice = 1 eater * $40/eater = $40What if Bob and Carol are a couple and Bob is paying for them both?

*

Allocation by Rate Method*

Introduction


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Objective:

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Methodology:

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Terminology:






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Enter Data


dinner check0


$160


BobTedCarolAlice0?


eaters0

&A

Page &P


Driver Usage



eaters11114

?

&A

Page &P


Rate Method




$1604=$40



Bob1x$40=$40

Ted1x$40=$40

Carol1x$40=$40

Alice1x$40=$40

Total$160

?

&A

Page &P


Proportion Method




Bob14=25%

Ted14=25%

Carol14=25%

Alice14=25%

Total100%



Bob25%x160=$40

Ted25%x160=$40

Carol25%x160=$40

Alice25%x160=$40

Total$160

?

&A

Page &P


Graph


Graph

0000

Dept. A

Dept. B

Dept. C

Dept. D

Print Range




$1604=$40



Bob1x$40=$40

Ted1x$40=$40

Carol1x$40=$40

Alice1x$40=$40

Total$160




Bob14=25%

Ted14=25%

Carol14=25%

Alice14=25%

Total100%



Bob25%x160=$40

Ted25%x160=$40

Carol25%x160=$40

Alice25%x160=$40

Total$160


Print Range

0000

Dept. A

Dept. B

Dept. C

Dept. D

MBD00000140.unknown

MBD001004EA.unknown

MBD00000190.unknown

MBD000000A0.unknown

MBD000000F0.unknown

MBD00000050.unknown

Allocation by Proportion MethodFirst, calculate each cost objects proportion:Driver units usedTotal driver units

Bob= 1 eater/4 eaters = 25%Carol = 1 eater/4 eaters = 25%Ted = 1 eater/4 eaters = 25%Alice = 1 eater/4 eaters = 25%

*

Allocation by Proportion MethodSecond, multiply each cost objects proportion by total cost poolBob= 25% * $160 = $40Carol = 25% * $160 = $40Ted = 25% * $160 = $40Alice = 25% * $160 = $40What if Bob and Carol are a couple and Bob is paying for them both?

*

Allocation by Proportion*

Introduction


?

Objective:

?

Methodology:

?

Terminology:






?








Enter Data


dinner check0


$160


BobTedCarolAlice0?


eaters0

&A

Page &P


Driver Usage



eaters11114

?

&A

Page &P


Rate Method




$1604=$40



Bob1x$40=$40

Ted1x$40=$40

Carol1x$40=$40

Alice1x$40=$40

Total$160

?

&A

Page &P


Proportion Method




Bob14=25%

Ted14=25%

Carol14=25%

Alice14=25%

Total100%



Bob25%x160=$40

Ted25%x160=$40

Carol25%x160=$40

Alice25%x160=$40

Total$160

?

&A

Page &P


Graph


Graph

0000

Dept. A

Dept. B

Dept. C

Dept. D

Print Range




$1604=$40



Bob1x$40=$40

Ted1x$40=$40

Carol1x$40=$40

Alice1x$40=$40

Total$160




Bob14=25%

Ted14=25%

Carol14=25%

Alice14=25%

Total100%



Bob25%x160=$40

Ted25%x160=$40

Carol25%x160=$40

Alice25%x160=$40

Total$160


Print Range

0000

Dept. A

Dept. B

Dept. C

Dept. D

MBD00000140.unknown

MBD001004EA.unknown

MBD00000190.unknown

MBD000000A0.unknown

MBD000000F0.unknown

MBD00000050.unknown

The Results*

Introduction


?

Objective:

?

Methodology:

?

Terminology:






?








Enter Data


dinner check0


$160


BobTedCarolAlice0?


eaters0

&A

Page &P


Driver Usage



eaters11114

?

&A

Page &P


Rate Method




$1604=$40



Bob1x$40=$40

Ted1x$40=$40

Carol1x$40=$40

Alice1x$40=$40

Total$160

?

&A

Page &P


Proportion Method




Bob14=25%

Ted14=25%

Carol14=25%

Alice14=25%

Total100%



Bob25%x160=$40

Ted25%x160=$40

Carol25%x160=$40

Alice25%x160=$40

Total$160

?

&A

Page &P


Graph


Graph

40404040

Bob

Ted

Carol

Alice

Print Range




$1604=$40



Bob1x$40=$40

Ted1x$40=$40

Carol1x$40=$40

Alice1x$40=$40

Total$160




Bob14=25%

Ted14=25%

Carol14=25%

Alice14=25%

Total100%



Bob25%x160=$40

Ted25%x160=$40

Carol25%x160=$40

Alice25%x160=$40

Total$160


Print Range

0000

Dept. A

Dept. B

Dept. C

Dept. D

MBD00000140.unknown

MBD001004EA.unknown

MBD00000190.unknown

MBD000000A0.unknown

MBD000000F0.unknown

MBD00000050.unknown

Learning CheckWhat is the rate per hour when the cost pool totals $30,000 and the total hours are 500?One of the cost objects uses 50 hours or resources from the cost pool described above. What is its proportion?*

Cross SubsidizationConsumption Cost allocationIs This Fair?Consumption Cost allocation*

Sheet:

Sheet:

Incremental EffectsWhat Happens if Bob Spends $10 More?OriginalIncrementalChange0102030405060708090Bob ConsumesBob Pays*

Dale R. Geiger 2011

Incremental EffectsWhat Happens if Bob Spends $10 Less?01020304050607080Bob ConsumesBob PaysIncrementalSavingsDecreased Amount*

Dale R. Geiger 2011

Allocation: a Zero-Sum GameThe Total is Constant Changing Allocation Basis Simply Redistributes CostIncreased Allocation for One Cost ObjectDecreases the Allocation for Other Cost ObjectsSometimes Called Balloon Squeezing or Peanut Butter Effect*

Measurement Effects MotivationManagerial Costing Inevitably Impacts BehaviorDesign of Managerial Costing Systems Must Recognize and Anticipate This EffectConsider in this ExampleWhat Incentives Exist to Spend More?What Incentives Exist to Spend Less?What Would You Do if You Went to Dinner with Them Tonight?*

ConclusionAllocation Based on Number of Eaters Failed to Reflect Resource ConsumptionResults:Unfair Cross-SubsidizationsThe Creation of Almost Free Incremental Goods Dysfunctional Behavioral MotivationDetailed Record Keeping May be Best in This Problem --i.e. Separate Checks*

Practical Exercises*

*IntroductionHave you ever been here? Deciding how to split the dinner check is a simple example of cost assignment or allocation. However, as the characters in the comic strip suggest, there are other things to consider besides the math. We will talk about how cost assignments can affect behaviors.

[Do we need permission to use this?]IntroductionTask: Allocate single Cost Pool to usersCondition: You are a cost advisor technician with access to all regulations/course handouts, and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors.Standard: with at least 80% accuracyExplain how poor cost information encourages undesired behaviorsCalculate driver rateCalculate proportion

**Introduction

This diagram illustrates that managerial costing translates raw accounting data (building blocks) into managerially useful information (symbolized by the textured box). The managerial costing translation is big gray area where the cost analyst must use professional judgment to make a good translation.*Introduction

Accounting systems generally dont meet management information needs because they are intended for external reporting purposes. The input or source costs they measure become the building blocks of the managerial costing system.Management is usually interested in measurements of output or consumption.Managerial costing makes the translation from source to consumption, or from input to output.

*Introduction

The illustration shows how common managerial costing terms fit into the model:

raw accounting data = cost poolmanagerial costing translation = method of distributionmanagerially useful information = cost object*Introduction

A cost pool is an aggregation of incurred costs (as measured by the accounting system) which must be distributed or assigned to cost objects.

Examples:Salary and benefits, supplies, travel, etc. in an airfield operations centerUtility bills for a garrison[Ask the students to suggest others]

*Introduction

Method of distribution is the mechanics of deriving management information from the cost pool. The source costs in the cost pool will be assigned or distributed to cost objects, those views of cost that are useful to management. Example: Determine unit cost by adding all input costs and dividing by number of units

*Introduction

Cost Object is a view of cost needed by management, or information in a format that will be useful to managementManagement may want to know:

-Product cost (120mm tube)-Service cost (Morale, Welfare and recreation)or -Organization, Customer or Consumer cost (Armor School)*Introduction

The primary method of distribution we will cover is Allocation.Allocation is a method of distribution that distributes the cost pool to the cost objects in the same proportion as a cost driver.Example: Distributing the cost of utilities to occupants in the same proportion as space occupied

The cost pool is utilities, the cost object is the occupants of the building. The cost driver is space occupied. Allocation would distribute 30% of the utility costs to an occupant who occupies 30% of the space in the building.*Activity step 1: Calculate driver rate and proportion

1. The following section focuses on the mechanics of allocation.

2. Allocation is a basic technique of activity based costing (ABC)

3. Becoming an expert is required but easy

4. It is important to understand Allocation --it is the foundation of managerial costing. Fortunately it is easy to understand.

5. This course provides a tool Allocation Mechanics Spreadsheet which illustrates the process very clearly.

6. Lets look at the basic algebraic equation.*Activity step 1: Calculate driver rate and proportion

1.There are two methods of allocation: the rate method and the proportion method.a. The Rate Method Uses a computed rate per driver unit. We will learn how to calculate the rate. b. The Proportion Method Computes a proportional share of the total cost based on driver usage. Well learn how to calculate the proportion and how to use it to assign cost to cost objects.

2. Note that both methods yield the same results, and represent two views of looking at the same equation*Activity step 1: Calculate driver rate and proportion

1. Rate Method:a. Under the rate method, the first step is to compute a rate per driver unit: 1. total cost pool total number of driver units2.The rate is represented by the orange-highlighted text. (If your driver is square feet, you will obtain a rate or dollar value per square foot)

b. The second step is to compute the allocation for the cost object: multiply the rate x number of driver units used by the cost object

1. Once we have calculated a rate per square foot, we multiply that times the number of square feet occupied by each of the buildings occupants, and that gives us total cost for each occupant.

2. Reconciling the two:a. The equation at the bottom of the slide shows an all purpose formula for computing allocation. The two methods just break the equation down in different ways. In the all-purpose equation, the elements of the rate equation are highlighted in orange to correspond to the rate calculation at the top of the page. The number of driver units used by each cost object is highlighted in green in both versions of the calculation.

*Activity step 1: Calculate driver rate and proportion

1. Proportion Method:a. In the proportion method, the first step is to Compute the proportion of driver usage: 1. number of driver units used by cost object Total number of driver units 2. This portion of the calculation is highlighted in red. This represents the percentage of the total cost driver units used by a particular cost object.(You will get a fraction, a decimal or a percentage)

b. Once you have the proportion for each cost object you can proceed to step 2, Compute the allocation for the cost object: 1. Multiply the Proportion x Total Cost Pool to yield the total cost allocated or assigned to the cost object

2. Reconciling the two:a. The calculation at the bottom of the slide shows an all purpose formula for computing allocation. The red-highlighted text represents the proportion calculation. The two methods just break the equation down in different ways. Students should recognize that they will arrive at the same answer regardless of which method they use (although there may be some rounding error) and they should use the method that makes the most sense to them or best suits the situation at hand.


Example: Splitting the dinner check

There are four people eating dinner together: a. Bob, Carol, Ted and Alice2. The check is $160. How should it be split?3. Notice a variety of entrees: b. one person had fillet and lobster, while another had only a Caesar salad. Activity step 1: Calculate driver rate and proportion

Its essential to identify the key pieces of information in any allocation problem. They are: Cost pool, cost object, and cost driver.


What is the cost pool? The dinner check of $160*Activity step 1: Calculate driver rate and proportionWhat are the cost objects?Bob, Carol, Ted and Alice*Activity step 1: Calculate driver rate and proportion

What is the cost driver? Number of persons (or eaters)

**Activity step 1: Calculate driver rate and proportion

1. This slide illustrates the use of the Allocation Mechanics Spreadsheet. The first page of the Excel workbook has white spaces for data entry. Enter the data as illustrated here.a. Cost Pool = dinner checkb. Total Cost =$ 160c. Cost Objects = Bob, Carol, Ted and Aliced. Cost Driver = eaters

Activity step 1: Calculate driver rate and proportion

First, calculate the driver rate. The formula for driver rate is: Total cost pool/Total driver units


The cost pool = $160Total driver units = 4 eaters


That yields a driver rate of:

Rate = $40/eater


Second, multiply by driver units used by each cost object:How many driver units used by each? If each is paying for him/herself, then each represents one driver unit (eater)


Bob= 1 eater * $40/eater = $40Carol = 1 eater * $40/eater = $40Ted = 1 eater * $40/eater = $40Alice = 1 eater * $40/eater = $40

Notice that the total is $160. That is, the entire dinner check has been allocated.*Activity step 1: Calculate driver rate and proportion

1. What if Bob and Carol are a couple and Bob is paying for them both?Bob= 2 eater * $40/eater = $80Carol = 0 eater * $40/eater = $0Ted = 1 eater * $40/eater = $40Alice = 1 eater * $40/eater = $40

2. The distribution would change but the total allocated is still equal to $160.**Activity step 1: Calculate driver rate and proportion

1. This slide shows how the spreadsheet calculates the allocation:

2. Total cost total number of eaters gives a rate of $40 per eater.

3. Each person, or cost object, represents one eater. 1 x $40 = $40

4. Note that this allocation is the same as the allocation made by the proportion method. Note that the whole $160 has been allocated.Activity step 1: Calculate driver rate and proportion

First, calculate each cost objects proportion:

Driver units used/Total driver units


1. Each cost objects proportion is:Bob= 1 eater/4 eaters = 25%Carol = 1 eater/4 eaters = 25%Ted = 1 eater/4 eaters = 25%Alice = 1 eater/4 eaters = 25%

Notice that the total of all proportions is equal to 100%*Activity step 1: Calculate driver rate and proportion

Second, multiply each cost objects proportion by total cost pool*Activity step 1: Calculate driver rate and proportion

1. Second, multiply each cost objects proportion by total cost poolBob= 25% * $160 = $40Carol = 25% * $160 = $40Ted = 25% * $160 = $40Alice = 25% * $160 = $40

Notice again that the sum of all cost objects allocations is equal to $160.*Activity step 1: Calculate driver rate and proportion

What if Bob and Carol are a couple and Bob is paying for them both?a. Bobs proportion is 2/4 = 50%b. 50% * $160 = $802. Bob= 50% * $160 = $803. Carol = 0% * $160 = $04. Ted = 25% * $160 = $405. Alice = 25% * $160 = $40

Notice again that all percentages add up to 100% and the total allocated is $160.**Activity step 1: Calculate driver rate and proportion

1.This slide shows the output from the proportion method, as computed by the Allocation Mechanics Spreadsheet.

2.The first step shows that each diner represents 1/4 or 25% of the driver usage.

3. This proportion is multiplied times the total cost of $160, giving each eater an allocation of $40

Note that the whole $160 is allocated.


Here are the results of the allocation based on eaters.

Q. What is the rate per hour when the cost pool totals $30,000 and the total hours are 500? A. $30,000/500 hours = $60/hour

Q. One of the cost objects uses 50 hours or resources from the cost pool described above. What is its proportion?A. 50 hours/500 hours = 10%

**Activity Step 2 Explain how poor cost information encourages undesired behaviors

1. This slide compares the dinner check allocation with actual consumption. The columns on the left show actual consumption, while the columns on the right show the allocation. This is known as the Peanut Butter Effect. The lumps in the actual consumption have been smoothed over by averaging.

2. Almost everyone has been in a situation like this. There are varying levels of consumption (As we noted earlier, one person ordered a Caesar Salad, while another ordered Fillet and Lobster.) Then, when the check comes, Usually it is the person who ordered the Fillet and Lobster that wants to split the check in this manner.*Activity Step 2 Explain how poor cost information encourages undesired behaviors

1. Say Bob was the high level consumer. Bob will only pay $40 for his consumption of $60.

2. If Bob consumes $10 more (the total bill goes to $170), how much more will he pay?

3. He will only pay $42.50 or an incremental change of $2.50. This is equal to 25 on the dollar. Economic theory tells us that as the cost of goods drops, the demand increases, and the demand for free goods is infinite. This may not be free goods, but it is pretty close. When the cost of goods is underreported, goods are over-consumed. *Activity Step 2 Explain how poor cost information encourages undesired behaviors

1. Similarly, if Bob decreases his consumption by $10 (total bill goes to $150) he will only save $2.50.

2. This illustrates one of the key problems when free goods are created: There is every incentive to consume more and little or no incentive to consume less.*Activity Step 2 Explain how poor cost information encourages undesired behaviors

1. A zero sum game means that the total cost pool remains the same. Using a different cost driver or allocation basis simply redistributes the same costs in different proportion.

2. If the allocation increases for one cost object, it will decrease for another, and vice versa. This is also known as squeezing the balloon (picture a balloonyou can push the air around to different parts of the balloon, but the total amount of air remains the same).*Activity Step 2 Explain how poor cost information encourages undesired behaviors

It is an inescapable fact that measurement impacts behavior. People are generally motivated to act in their own self interest, and the cost system must recognize and anticipate this.

*Activity Step 2 Explain how poor cost information encourages undesired behaviors

This problem, while illustrating the mechanics of allocation, does not reflect true consumption because the cost driver number of eaters does not reflect consumption.

Allocation Based on Number of Eaters Failed to Reflect Resource Consumptiona. Results:1. Unfair Cross-Subsidizations2. The Creation of Almost Free Incremental Goods 3. Dysfunctional Behavioral Motivation

3. Detailed Record Keeping May be Best in This Problem --i.e. Separate Checks

allocate single cost pool to users 1. have you ever been here? 2

Documents

cost objects

total cost

view of cost

unit cost

cost of utilities

cost driverexample

single cost pool

cost pool example