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Chapter 07 - Cost Allocation: Departments, Joint Products, and By-Products
7-24 Cost Allocation and Taxation at Nonprofit Organizations (10 min)
The nonprofit has an incentive to allocate a relatively large portion of the
common costs to the business activity to reduce taxes, but current Treasury
regulations require that the cost allocation be reasonable. This has led
some to argue that common costs should not be allocated in these cases.
However, an analytical study (using economic models) of the economic
Based on an article by Daniel Tinkelman, “Nonprofit Organizations’ Cost
Allocations,” The CPA Journal, July 2005. See also, Michelle H. Yetman
and Robert J. Yetman, “The Effects of Governance on the Accuracy of
Charitable Expenses Reported by Nonprofit Organizations,” Contemporary
Accounting Research, September 2012, pp 738-767.
7-11
Education.
7-25 Fuel Surcharges: Allocating the Increased Cost of Fuel (20
min)
1.,2.
The rising cost of fuel has affected many industries, but particularly
those in the transportation industries. In air freight, trucking, and
railroads, the surcharges can be as high as 35% of average charges.
The surcharges can be a substantial portion of total revenues for
The issue of surcharges for railroads has been a contentious
one for the shippers and railroads. There have been several law
suits regarding the conflicts and currently several of the largest U.S.
railroads are subject to a suit charging price fixing regarding their use
of surcharges. The railroads’ attempt to have the suit dismissed
recently failed in U.S. courts (https://ecf.dcd.uscourts.gov/cgi-
bin/show_public_doc?2007mc0489-138). Apparently the STB ruling in
January 2007 was ineffective in resolving the surcharge issue for the
railroads and shippers. One reason it may have failed is that it
did not provide clear guidance regarding what would be an
fuel cost increases. Also, one might consider an allocation that is
based on both miles and weight of product shipped. The goal is to
find the causal link between the use of fuel and the railroads’ service
to the shipper.
The railroads in 2012 and 2013 appealed the certification of the
The litigation is on-going, as of August 2014.
See an August 12, 2013 report in Claims Journal by Andrew Zajac and Tom
Schoenberg, “Railroads Win Class Certification Appeal in Price-Fix Case,
http://www.claimsjournal.com/news/national/2013/08/12/234720.htm
7-12
Chapter 07 - Cost Allocation: Departments, Joint Products, and By-Products
7-25 (continued -1)
3. The sustainability issue arises in the case of rail transport because
rail transport is more efficient than truck transport. A shipper that
has the option between the two methods of transport should consider
Based on: “U.S. Appellate Court Reverses Class-certification
Decision for Fuel Surcharge-fixing Lawsuit Against Four Class Is,”
August 12, 2013,
http://www.progressiverailroading.com/norfolk_southern/news/US-
appellate-court-reverses-classcertification-decision-for-fuel-
surchargefixing-lawsuit-against-four-Class-Is--37234;
Also, Christine Hauser, “Shippers May Raise Fuel Fees,” The New
York Times, April 26, 2011; Mina Kimes, “Railroads: Cartel or Free
Market Success Story?” Fortune, September 26, 2011; John D.
Schultz, “Fuel Surcharge Lawsuits: Antitrust Fines Growing,”
Logistics Management, July 1, 2008;Gargi Chakrabarty, “Many
Businesses in no Hurry to Pass on Savings,” Rocky Mountain News,
October 31, 2008.
7-13
Education.
Chapter 07 - Cost Allocation: Departments, Joint Products, and By-Products
7-26 Cost Allocation and Legal Disputes (30 Min)
The actual case is based on a dispute between the Department of Health
and Family Services (DHFS) of the State of Wisconsin and St. Francis
Home in the Park (the nursing home). The judgments shown below are by
the State of Wisconsin Court of Appeals, dated March 23, 1999. The full
explanation of the case is at the following site:
https://www.wicourts.gov/ca/opinion/DisplayDocument.html?
content=html&seqNo=13846
1. The court determined that further documentation was not required,
but that the stated reason for charging these items to the nursing
home is persuasive, and that further, DHFS had not shown that it had
costs to the nursing home was therefore allowed.
2. The court determined that DHFS had “no substantial basis” for
disallowing the direct assignment of the nourishment costs to the
nursing home. The court judged that it was apparent that the nursing
the costs should therefore be traced directly to the nursing home.
3. The court again agreed with NCI’s position, stating that it was
unreasonable for NCI to provide a fully reliable system for only a few
court disallowed DHFS’s objection.
4. Both parties were asked and agreed that the square footage basis for
allocation of costs does not represent actual electricity usage. The
court stated: “..the square footage allocation wrongly assumes that
electricity is a fixed overhead cost that does not vary with the level of
substantial basis to disallow the method used by NCI.
5. The argument that NCI competes in the same manner (cost
leadership) for both the nursing home and the apartment-retirement
home is arguable. Is there evidence that the retirement home is a
7-14
Education.
Chapter 07 - Cost Allocation: Departments, Joint Products, and By-Products
7-27 Cost Allocation; Cost Shifting (15 min)
1. The cost-shifting in this case is from the airlines (that experience
lower costs of baggage handling) to TSA (that experience a larger
number of “carry-on” bags to examine) and to the airline passengers
(who experience the discomfort of increased time in going through
TSA security and the cost of the $2.50 security fee that is included in
each passenger’s one-way ticket.
Note: because of increased baggage handling and security
responsibilities, the Transportation Security Administration (TSA) has
at the gate because the increase in the number of carry-on bags
exceeds the aircraft’s capacity for these bags.
2. Cost-shifting is frequently an area of ethical concern, as it involves
shifting the cost burden from one entity or individual to another.
new charges and delays, and others seeking low air fares.
3. Given the emphasis airline customers place on price, air travel has
become somewhat of a commodity. It is hard to differentiate the
different carriers. The “fees for services” approach is consistent with
Source: See Real World Focus “Commodities, Globalization and Cost
Leadership,” in Chapter 1, p 17. Also, Christine Negroni, “More Fees,
More Carry-Ons,” The New York Times, March 29, 2011, p B4; Michelle
Higgins, “Elite for a Day, In Coach for a Fee,” The New York Times,
September 4, 2011. “For TSA security fee information, see www.TSA.gov.
7-15
Education.
Chapter 07 - Cost Allocation: Departments, Joint Products, and By-Products
7-28 Departmental Cost Allocation (25 min)
1. The Direct Method
Net service to both Production Departments (Advertising and Sales)
for the Actuarial Service Dept:
100% - 80% = 20%
Advertising Department share: 10%/20% = .5
Sales Department share: 10%/20% = .5
Net Service to both Production Departments for Premium
Department:
Advertising
Department
Sales Department
Actuarial Department
cost allocation
$80,000 x .5 = $40,000 $80,000 x .5 = $40,000
Dept. Costs
Total Cost for Each
Production Dept.
$103,750 $91,250
2. Step Method
The Actuarial Department goes first, since it provides the greatest
service to other service departments.
7-16
Chapter 07 - Cost Allocation: Departments, Joint Products, and By-Products
7-28 (continued -1)
Premium Dept. Advertising Dept Sales Dept
Allocation of
Actuarial Dept
$80,000 x .8 =
$64,000
$80,000 x .1 =
$8,000
$80,000 x .1 =
$8,000
Allocation of
($64,000 +
($64,000 +
Costs
Total Cost for
Each Production
Department
$87,750 $107,250
3. The Reciprocal Method
Solve the Simultaneous Equations: (S1=actuarial; S2=premium)
S1 = $80,000 + (.2 x S2)
S2 = $15,000 + (.8 x S1)
S2 = $94,048
Advertising
Department
Sales Department
Actuarial Department
cost allocation
$98,810 x .1 = $9,881 $98,810 x .1 = $9,881
Production Dept.
7-17
Education.
Chapter 07 - Cost Allocation: Departments, Joint Products, and By-Products
7-29 Departmental Cost Allocation (30 min)
First, find the unknown service rates:
From S1 to P2 = 100% - 10% - 20% = 70%
From S2 to P1 = 100% - 10% - 30% = 60%
1. The Direct Method
Net service to both Production Departments for Service
Department 1: 100% - 10% = 90%
Production Department 1 share: 60%/90% = 2/3
Production Department 2 share: 30%/90% = 1/3
Production
Department 1
Production
Department 2
Service department 1
cost allocation
$180,000 x 2/9 =
$40,000
$180,000 x 7/9 =
$140,000
Service department 2
cost allocation
$60,000 x 2/3 =
$40,000
$60,000 x 1/3=
$20,000
Production Dept.
7-18
Education.
Chapter 07 - Cost Allocation: Departments, Joint Products, and By-Products
7-29 (continued -1)
2. Step Method
Both service departments serve each other the same percentage of
total service; hence, either can go first. Here, Service Dept 1 goes
first on the basis that it has the highest total cost:
Service Dept 2 Production Dept
1
Production Dept
2
Allocation of
Service Dept 1
$180,000 x .1 =
$18,000
$180,000 x .2 =
$36,000
$180,000 x .7 =
$126,000
Allocation of
Service Dept 2
($60,000 +
$18,000) x 2/3 =
$52,000
($60,000 +
$18,000) x 1/3 =
$26,000
Department
7-19
Education.
Chapter 07 - Cost Allocation: Departments, Joint Products, and By-Products
7-29 (continued -2)
3. The Reciprocal Method
Solve the Simultaneous Equations:
S1 = $180,000 + (.1 x S2)
S2 = $60,000 + (.1 x S1)
S1 = $180,000 + [.1 x ($60,000 +.1 x S1)]
Production Department 1 Production Department 2
Service Dept 1
cost allocation
$187,879 x .2 =
$37,576
$187,879 x .7 = $131,515
Service Dept 2
cost allocation
$78,788 x .6 = $47,273 $78,788 x .3 = $23,636
Prod. Dept.
7-20
Education.
