allocate single cost pool to users © dale r. geiger 20111

Allocate Single Cost Pool to Users

Principles of Cost Analysis and Management

© Dale R. Geiger 2011 1

Have you ever been here?

2© Dale R. Geiger 2011

Terminal Learning Objective

• Task: Allocate Single Cost Pool to Users• Condition: 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% accuracy• Explain how poor cost information encourages undesired

behaviors• Calculate driver rate• Calculate proportion


A Broad Definition of Managerial Costing

raw accounting data

managerial costing

translation

managerially useful information


Why Is This Translation Needed?

• Accounting Systems usually measure input or source costs• Labor, overhead, materials• Salaries, benefits, supplies, contracts

• Managers want measurements based on output or consumption • Product, service, project• Consuming organization, customer


Managerial Costing Terms

raw accounting data

managerial costing

translation

managerially useful information

=

cost pool

method of

distribution

cost object


Terminology

• Cost pool: • An aggregation of incurred or

source costs to be distributed• Examples:

• Salary and benefits, supplies, travel, etc. in an airfield operations center

• Utility bills for a garrison

cost pool


Terminology

• Method 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 units

method of

distribution


Terminology

• Cost Object: • A view of cost needed by

management • Examples:

• 120mm tube product cost• Morale, welfare, recreation cost• Armor school cost

cost object


What is Allocation?

• Allocation: • A method of distribution that

distributes cost pool to cost objects in the same proportion as cost driver

• Example:• Distributing the cost of utilities

to occupants in the same proportion as space occupied

allocation based on

cost driver


The Mechanics of Allocation

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

• Becoming an expert is required but easy

• Allocation mechanics excel spreadsheet makes it even easier

allocation based on

cost driver


Two Allocation Methods

• Rate Method: • Uses a computed rate per driver unit

• Proportion Method: • Computes a proportional share of the total cost

based on driver usage• Both Methods

• Yield same results• Represent the same underlying algebra


Reconciling the Two Methods

Total Cost PoolTotal Number of Driver Units

* Number of Driver Units Used

Number of Driver Units Used Total Number of Driver Units

* Total Cost Pool

Number of Driver Units Used * Total Cost PoolTotal Number of Driver Units

Equals

Equals

Rate Method

ProportionMethod


Split the Dinner Check

Thank You

Fillet 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 $160.00

Chez Paris

Bob

Carol

Ted

Alice


Identifying Key Information

• What is the cost pool?• The dinner check of $160

• What are the cost objects?• Bob, Carol, Ted and Alice

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


Allocation Mechanics.xls

Enter the Name of the Cost Pool to be Allocated here:dinner check 0

Enter the Total Cost of dinner check here:160$

Enter the Names of the Cost Objects here:

Bob Ted Carol Alice 0 ?

Enter the Name of the Cost Driver here:eaters 0

Reset


Allocation by Rate Method

• First, calculate the driver rate:Total cost pool

Total driver units

Cost pool = $160Total driver units = 4 eaters

Rate = $40/eater© Dale R. Geiger 2011 21



Total driver units




• Second, multiply by driver units used by each cost object:• Bob = 1 eater * $40/eater = $40• Carol = 1 eater * $40/eater = $40• Ted = 1 eater * $40/eater = $40• Alice = 1 eater * $40/eater = $40• What if Bob and Carol are a couple and Bob is

paying for them both?



1. Determine Overhead Rate:

Total Cost ÷ Total eaters = Rate per eaters

160$ ÷ 4 = 40$

2. Compute Allocation:

Usage by Cost Object x Rate = AllocationBob 1 x 40$ = 40$ Ted 1 x 40$ = 40$ Carol 1 x 40$ = 40$ Alice 1 x 40$ = 40$ Total 160$

Reset


Allocation by Proportion Method

• First, calculate each cost object’s 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%



• First, calculate each cost object’s 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%



• Second, multiply each cost object’s proportion by total cost pool• Bob = 25% * $160 = $40• Carol = 25% * $160 = $40• Ted = 25% * $160 = $40• Alice = 25% * $160 = $40• What if Bob and Carol are a couple and Bob is



Allocation by Proportion

1. Determine Proportion of ConsumptionUsage by Cost Object ÷ Total eaters = %

Bob 1 ÷ 4 = 25%

Ted 1 ÷ 4 = 25%

Carol 1 ÷ 4 = 25%

Alice 1 ÷ 4 = 25%Total 100%

2. Multiply Proportion by Total CostCost Object % x Total dinner check = Allocation

Bob 25% x 160 = 40$

Ted 25% x 160 = 40$

Carol 25% x 160 = 40$

Alice 25% x 160 = 40$ Total 160$

© Dale R. Geiger 201133

The Results

Cost Allocation for dinner check Based on eaters

$-

$10

$20

$30

$40

Bob

Ted

Carol

Alice

Print

Reset

© Dale R. Geiger 201134

Check on Learning

• What 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 Subsidization

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Consumption Cost allocation

Is This Fair?

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Consumption Cost allocation© Dale R. Geiger 2011

36

Incremental EffectsWhat Happens if Bob Spends $10 More?

Original

IncrementalChange

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Bob Consumes Bob Pays


Incremental EffectsWhat Happens if Bob Spends $10 Less?

0

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Bob Consumes Bob Pays

DecreasedAmountBob’s ActualConsumption And Payment


Allocation: a Zero-Sum Game

• The Total is Constant • Changing allocation basis simply redistributes cost

• Increased Allocation for One Cost Object• Decreases the allocation for other cost objects

• Sometimes called “Balloon Squeezing” or “Peanut Butter Effect”


Measurement Effects Motivation

• Managerial costing inevitably impacts behavior• Design of managerial costing systems must

recognize and anticipate this effect• Consider in this example

• What iIncentives exist to spend more?• What incentives exist to spend less?• What would you do if you went to dinner with

them tonight?


• Why did allocation based on number of eaters fail to reflect resource consumption?

• What are the effects of incorrect allocation?

• What might be a better method of allocation in the dinner check case?


Check on Learning

Practical Exercises


allocate single cost pool to users © dale r. geiger 20111

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