Demonstration Problem 1
A developer plans to buy a parcel of land and construct an office building on top of it. He
narrows his search to two possible lots in adjacent states with convenient access to highways.
The expected returns from Lots C and D are $190,000 and $210,000, respectively.
Required:
What is the opportunity cost of funds the developer uses to purchase Lot D?
Demonstration Problem 1 – Solution
The opportunity cost of funds the developer uses to purchase Lot D is the forgone return the
developer could have earned from purchasing Lot C, assuming that both investments are equal in
risk and liquidity
Demonstration Problem 2
Kahn Industry, Inc. has three divisions. The following information was available for last quarter.
Division A
Division B
Division C
Company
Revenues
$200,000
$320,000
$140,000
$660,000
Cost of goods (or services) sold
160,000
240,000
100,000
500,000
Gross margin
$240,000
$ 80,000
$ 40,000
$160,000
Marketing and administrative costs
18,000
20,000
12,000
50,000
Operating profit
$ 22,000
$ 60,000
$ 28,000
$110,000
Interest
10,000
Income taxes (30%)
30,000
Net income
$ 70,000
The CEO of Kahn Industry wanted to allocate the interest cost of $10,000 to the three divisions.
Required:
1. Identify the cost object(s) and the cost pool.
2. Allocate the interest cost based on each division’s (1) revenues, (2) gross margin, and (3)
operating profit.
3. Draw a cost flow diagram assuming the allocation of interest cost is based on revenues.
Demonstration Problem 2 – Solution
Part 1
The cost objects are the three divisions; the cost pool is the interest cost incurred for the
company as a whole.
Part 2
Division A
Division B
Division C
Total
(1) Revenues
$200,000
$320,000
$140,000
$660,000
Allocation rule
30.3%a
48.5%b
21.2%c
100%
Allocation
$3,030
$4,850
$2,120
$10,000
(2) Gross margin
$40,000
$80,000
$40,000
$160,000
Allocation rule
25%
50%
25%
100%
Allocation
$2,500
$5,000
$2,500
$10,000
(3) Operating profit
$22,000
$60,000
$28,000
$110,000
Allocation rule
20.0%
54.5%
25.5%
100%
Allocation
$2,000
$5,450
$2,550
$10,000
Cost Pool
30.3%
48.5%
21.2%
