SOLUTION
(20 min.) Revenue allocation, bundled products.
1a. Under the stand-alone revenue-allocation method based on selling price, Smarty will be
allocated 40% of all revenues, or $36 of the bundled selling price, and Sublime will be allocated
60% of all revenues, or $54 of the bundled selling price, as shown below.
Stand-alone method, based on selling
prices Smarty Sublime Total
1b. Under the incremental revenue-allocation method, with Smarty ranked as the primary
product, Smarty will be allocated $40 (its own stand-alone selling price), and Sublime will be
allocated $50 of the $90 selling price, as shown below.
Incremental Method
(Smarty rank 1) Smarty Sublime
1c. Under the incremental revenue-allocation method, with Sublime ranked as the primary
product, Sublime will be allocated $60 (its own stand-alone selling price) and Smarty will be
allocated $30 of the $90 selling price, as shown below.
Incremental Method
(Sublime rank 1) Smarty Sublime
1d. Under the Shapley value method, each product will be allocated the average of its
allocations in 1b and 1c, i.e., the average of its allocations when it is the primary product and
when it is the secondary product, as shown below.
Shapley Value Method Smarty Sublime
Average of allocated selling price
2. A summary of the allocations based on the four methods in requirement 1 is shown below.
Stand-alone
(Selling Prices)
Incremental
(Smarty first)
Incremental
(Sublime first) Shapley
If there is no clear indication 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 (since
Couture sold the same quantities of Smarty and Sublime individually), the Shapley value method
is the fairest of all the methods because it averages the effect of product rank. In this particular
15-26 Allocation of common costs. Jim Dandy Auto Sales uses all types of media to advertise
its products (television, radio, newspaper, Internet, and so on). At the end of 2016, the company
president, Jim McKinnley, decided that all advertising costs would be incurred by corporate
headquarters and allocated to each of the company’s four sales locations based on number of
vehicles sold. Jim was confident that his corporate purchasing manager could negotiate better
advertising contracts on a corporate-wide basis than each of the sales managers could on their
own. McKinnley budgeted total advertising cost for 2017 to be $1.6 million. He introduced the
new plan to his sales managers just before the New Year. The managers had already drawn up
their advertising plans for 2017 and the corporate plan would do the same advertising for them as
they had planned. Total advertising costs for 2017 were $1,600,000. If the managers had done
this same advertising on their own, their advertising costs would be as follows:
The manager of the East sales location, Tom Stevens, was not happy. He complained that the new
allocation method was unfair and increased his advertising costs significantly. The East location
sold high volumes of low-priced used cars and most of the corporate advertising budget was
related to new car sales.
Required:
1. Show the amount of the 2017 advertising cost ($1,600,000) that would be allocated to each
of the divisions under the following criteria:
a. McKinnley’s allocation method based on number of cars sold
b. The stand-alone method if divisions had done their own advertising
c. The incremental-allocation method, with divisions ranked on the basis of dollars they
would have spent on advertising in 2017
2. Which method do you think is most equitable to the divisional sales managers? What other
options might President Jim McKinnley have for allocating the advertising costs?
SOLUTION
(20-25 min. ) Allocation of common costs.
1. a. McKinnley’s method based on number of cars sold:
Sales
Location
(1)
Number of
cars sold
(2)
Percentage
(3) = (2) ÷ 14,000
Joint Cost
(4)
Allocation
(5) = (3) × (4)
1. b. Stand-alone method:
Sales
Location
(1)
Stand-alone
cost
(2)
Percentage
(costs in thousands)
(3) = (2) ÷ $2,180
Joint Cost
(4)
Allocation
(5) = (3) × (4)
1. c. Incremental method (locations ranked in order of largest advertising dollars to smallest
advertising dollars):
Sales Location Allocated Cost Cost Remaining to Allocate
East 0
2. In this situation, the stand-alone method is probably the best method because the weights it
uses for allocation are based on the individual advertising cost for each location as a separate
entity. Therefore, each entity gets the same relative proportion of advertising costs, and each
15-27 Single-rate, dual-rate, and practical capacity allocation. Preston Department Store has
a new promotional program that offers a free gift-wrapping service for its customers. Preston’s
customer-service department has practical capacity to wrap 5,000 gifts at a budgeted fixed cost
of $4,950 each month. The budgeted variable cost to gift-wrap an item is $0.35. During the most
recent month, the department budgeted to wrap 4,500 gifts. Although the service is free to
customers, a gift-wrapping service cost allocation is made to the department where the item was
purchased. The customer-service department reported the following for the most recent month:
Required:
1. Using the single-rate method, allocate gift-wrapping costs to different departments in these
three ways:
a. Calculate the budgeted rate based on the budgeted number of gifts to be wrapped and
allocate costs based on the budgeted use (of gift-wrapping services).
b. Calculate the budgeted rate based on the budgeted number of gifts to be wrapped and
allocate costs based on actual usage.
c. Calculate the budgeted rate based on the practical gift-wrapping capacity available and
allocate costs based on actual usage.
2. Using the dual-rate method, compute the amount allocated to each department when (a) the
fixed-cost rate is calculated using budgeted fixed costs and the practical gift-wrapping
capacity, (b) fixed costs are allocated based on budgeted fixed costs and budgeted usage of
gift-wrapping services, and (c) variable costs are allocated using the budgeted variable-cost
rate and actual usage.
3. Comment on your results in requirements 1 and 2. Discuss the advantages of the dual-rate
method.
SOLUTION
(20 min.) Single-rate, dual-rate, and practical capacity allocation.
1.a. Allocation based on budgeted usage of gift-wrapping services:
1.b. Allocation based on actual usage of gift-wrapping services:
Allocation based on actual usage of gift-wrapping services:
2. Budgeted rate for fixed costs =
Budgeted fixed costs
Practical capacity
Fixed costs allocated on budgeted usage.
Variable costs based on actual usage.
Allocation:
Department Variable Costs Fixed Costs Total
3. The dual-rate method has two major advantages over the single-rate method:
a. Fixed costs and variable costs can be allocated differently—fixed costs based on rates
b. Fixed costs are allocated proportionately to the departments causing the incurrence of
Note: If capacity costs are the result of a long-term decision by top management, it may be
desirable to allocate to each department the cost of capacity used based on budgeted (or actual)
usage. The users are then not allocated the costs of unused capacity.
15-28 Revenue allocation. Fang Inc. produces and sells DVDs to business people and
students who are planning extended stays in China. It has been very successful with two
DVDs: Beginning Mandarin and Conversational Mandarin. It is introducing a third DVD,
Reading Chinese Characters. It has also decided to market its new DVD in two different
packages grouping the Reading Chinese Characters DVD with each of the other two language
DVDs. Information about the separate DVDs and the packages follow.
Required:
1. Using selling prices, allocate revenues from the BegM + RCC package to each DVD in that
package using (a) the stand-alone method; and (b) the incremental method, with BegM and
RCC in turn as the primary product.
2. Using the selling prices, allocate revenues from the ConM + RCC package to each DVD in
that package using (a) the stand-alone method; and (b) the incremental method, with ConM
and RCC in turn as the primary product.
3. Which method is most appropriate for allocating revenues among the DVDs? Why?
SOLUTION
(20 min.) Revenue allocation
1. a. Stand-alone method for the BegM + RCC package
DVD
(1)
Separate
Revenue
(2)
Percentage
(3) = (2) ÷ $120
Joint
Revenue
(4)
Allocation
(5) = (3) × (4)
1. b. Incremental method
i) Allocated Revenue Revenue Remaining
(BegM first) To Allocate
ii) Allocated Revenue Revenue Remaining
(RCC first) To Allocate
1. c. Shapley method (assuming each DVD is demanded in equal proportion)
2. a. Stand-alone method for the ConM + RCC package
DVD
(1)
Separate
Revenue
(2)
Percentage
(3) = (2) ÷ $160
Joint
Revenue
(4)
Allocation
(5) = (3) × (4)
2. b. Incremental method
i) Allocated
Revenue
(ConM first)
Revenue
Remaining
To Allocate
ii) Allocated
Revenue
(RCC first)
Revenue
Remaining
To Allocate
2. c. Shapley method (assuming each DVD is demanded in equal proportion)
2. For each DVD package, the stand-alone method and the Shapley method give approximately
The incremental method would be appropriate if one DVD (BegM or ConM) has a higher
15-29 Fixed-cost allocation. Central University completed construction of its newest
administrative building at the end of 2017. The University’s first employees moved into the
building on January 1, 2018. The building consists of office space, common meeting rooms
(including a conference center), a cafeteria, and even a workout room for its exercise enthusiasts.
The total 2018 building space of 250,000 square feet was utilized as follows:
The new building cost the university $40 million and was depreciated using the straight-line
method over 20 years with zero residual value so $2,000,000 per year. At the end of 2018 three
departments occupied the building: executive offices of the president, accounting, and human
resources. Each department’s usage of its assigned space was as follows:
Required:
1. How much of the total annual building cost of $2,000,000 will be allocated in 2018 to each
of the departments, if the cost is allocated to each department on the basis of the following?
a. Actual usage of the three departments
b. Planned office space of the three departments
c. Practical capacity of the three departments
2. Assume that Central University allocates the total annual building cost of $2,000,000 in the
following manner:
a. All vacant office space is absorbed by the university and is not allocated to the
departments.
b. All occupied office space costs are allocated on the basis of actual square footage used by
each department.
c. All common area costs are allocated on the basis of a department’s practical capacity.
Calculate the cost allocated to each department in 2018 under this plan. Do you think the
allocation method used here is appropriate? Explain.