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SOLUTION
(50 min.) Support-department cost allocation, reciprocal method (continuation of 15-19).
1a.
Support Departments Operating Departments
AS I S Govt. Corp.
Reciprocal Method Computation
1b.
Support Departments Operating Departments
AS I S Govt. Corp.
Costs $600,000 $2,400,000
1st Allocation of AS
(0.25, 0.40, 0.35) (600,000) 150 ,000 $ 240,000 $ 210,000
2,550,000
2.
Govt. Consulting Corp. Consulting
The four methods differ in the level of support department cost allocation across support
departments. The level of reciprocal service by support departments is material. Administrative
The reciprocal method recognizes all the interactions and is thus the most accurate. This is
especially clear from looking at the repeated iterations calculations.
15-21 Direct and step-down allocation. E-books, an online book retailer, has two operating
departments—corporate sales and consumer sales—and two support departments—human
resources and information systems. Each sales department conducts merchandising and marketing
operations independently. E-books uses number of employees to allocate human resources costs
and processing time to allocate information systems costs. The following data are available for
September 2017:
Required:
1. Allocate the support departments’ costs to the operating departments using the direct method.
2. Rank the support departments based on the percentage of their services provided to other
support departments. Use this ranking to allocate the support departments’ costs to the
operating departments based on the step-down method.
3. How could you have ranked the support departments differently?
SOLUTION
(40 min.) Direct and step-down allocation.
1.
Support Departments Operating Departments
HR Info. Systems Corporate Consumer Total
2. Rank on percentage of services rendered to other support departments.
Step 1: HR provides 23.077% of its services to information systems:
0
3. An alternative ranking is based on the dollar amount of services rendered to other support
departments. Using numbers from requirement 2, this approach would use the following
sequence:
15-22 Reciprocal cost allocation (continuation of 15-21). Consider E-books again. The
controller of E-books reads a widely used textbook that states that “the reciprocal method is
conceptually the most defensible.” He seeks your assistance.
Required:
1. Describe the key features of the reciprocal method.
2. Allocate the support departments’ costs (human resources and information systems) to the
two operating departments using the reciprocal method. Use (a) linear equations and (b)
repeated iterations.
3. In the case presented in this exercise, which method (direct, step-down, or reciprocal) would
you recommend? Why?
SOLUTION
(30 min.) Reciprocal cost allocation (continuation of 15-21).
1. The reciprocal allocation method explicitly includes the mutual services provided among
all support departments. Interdepartmental relationships are fully incorporated into the support
department cost allocations.
2. HR = $72,700 + 0.08333 IS
Support Depts. Operating Depts.
HR Info. Systems Corporate Consumer Total
Alloc. of Info. Syst. costs
Solution Exhibit 15-22 presents the reciprocal method using repeated iterations.
SOLUTION EXHIBIT 15-22
Reciprocal Method of Allocating Support Department Costs for September 2012 at
E-books Using Repeated Iterations
Support Departments Operating Departments
Human
Resources
Information
Systems
Corporate
Sales
Consumer
Sales Total
Budgeted manufacturing overhead costs
before any interdepartmental cost allocation $72,700 $234,400 $998,270 $489,860 $1,795,230
Total accounts allocated and reallocated (the numbers in parentheses in first two columns)
3. The reciprocal method is more accurate than the direct and step-down methods when there
are reciprocal relationships among support departments.
A summary of the alternatives is:
Corporate Sales Consumer Sales
The reciprocal method is the preferred method although, for September 2017, the numbers do not
appear materially different across the alternatives.
15-23 Allocation of common costs. Evan and Brett are students at Berkeley College. They
share an apartment that is owned by Brett. Brett is considering subscribing to an Internet
provider that has the following packages available:
Evan spends most of his time on the Internet (“everything can be found online now”). Brett
prefers to spend his time talking on the phone rather than using the Internet (“going online is a
waste of time”). They agree that the purchase of the $90 total package is a “win–win” situation.
Required:
1. Allocate the $90 between Evan and Brett using (a) the stand-alone cost-allocation method,
(b) the incremental cost-allocation method, and (c) the Shapley value method.
2. Which method would you recommend they use and why?
SOLUTION
(2025 min.) Allocation of common costs.
1. Three methods of allocating the $90 are:
Evan Brett
a. Stand-alone cost allocation method.
$75
$75 + $25
3
4
Brett:
$25
$75 + $25
$90 =
1
4
$90 = $22.50
b. Incremental cost allocation method.
Assume Brett (the owner) is the primary user and Evan is the incremental user:
User
Costs
Allocated
Cumulative Costs
Allocated
Total
$ 90
This method may generate some dispute over the ranking. Notice that Evan pays only
$65 despite his prime interest in the more expensive Internet access package. Brett could make
the argument that if Evan were ranked first he would have to pay $75 because he is the major
Internet user. Then, Brett would only have to pay $15!
Assume Evan is the primary user and Brett is the incremental user:
User
Costs
Allocated
Cumulative Costs
Allocated
Total
$ 90
c. Shapley value (average over costs allocated as the primary and incremental user).
User
Costs
Allocated
¸
2. The Shapley value approach is recommended. It is fairer than the incremental method
because it avoids considering one user as the primary user and allocating more of the common
More generally, other criteria to guide common cost allocations include the following:
a. Cause and effect. It is not possible to trace individual causes (either Internet access or
b. Benefits received. There are various ways of operationalizing the benefits received:
(i) Monthly service charge for their prime interest––Internet access for Evan ($75),
(ii) Actual usage by each person. This would involve keeping a record of usage by
15-24 Allocation of common costs. Gordon Grimes, a self-employed consultant near Atlanta,
received an invitation to visit a prospective client in Seattle. A few days later, he received an
invitation to make a presentation to a prospective client in Denver. He decided to combine his
visits, traveling from Atlanta to Seattle, Seattle to Denver, and Denver to Atlanta.
Grimes received offers for his consulting services from both companies. Upon his return, he
decided to accept the engagement in Denver. He is puzzled over how to allocate his travel costs
between the two clients. He has collected the following data for regular round-trip fares with no
stopovers:
Grimes paid $900 for his three-leg flight (Atlanta–Seattle, Seattle–Denver, Denver–Atlanta). In
addition, he paid $45 each way ($90 total) for limousines from his home to Atlanta Airport and
back when he returned.
Required:
1. How should Grimes allocate the $900 airfare between the clients in Seattle and Denver using
(a) the stand-alone cost-allocation method, (b) the incremental cost-allocation method, and
(c) the Shapley value method?
2. Which method would you recommend Grimes use and why?
3. How should Grimes allocate the $90 limousine charges between the clients in Seattle and
Denver?
SOLUTION
(20 min.) Allocation of common costs.
1. Alternative approaches for the allocation of the $900 airfare include the following:
a. The stand-alone cost allocation method. This method would allocate the air fare on
the basis of each client’s percentage of the total of the individual stand-alone costs.
Advocates of this method often emphasize an equity or fairness rationale.
b. The incremental cost allocation method. This requires the choice of a primary party
and an incremental party.
One rationale is that Grimes was planning to make the Seattle trip, and the Denver stop was
added subsequently. Some students have suggested allocating as much as possible to the Seattle
client because Grimes had decided not to work for them.
If the Denver client is the primary party, the allocation would be:
One rationale is that the Denver client is the one who is going to use Grimes’s services and,
presumably, receives more benefits from the travel expenditures.
c. Grimes could calculate the Shapley value that considers each client in turn as the
primary party: The Seattle client is allocated $600 as the primary party and $500 as the
2. Grimes should use the Shapley value method. It is fairer than the incremental method
because it avoids considering one party as the primary party and allocating more of the common
The Shapley value (or the stand-alone cost allocation method) would be the preferred
methods if Grimes was to send the travel expenses to the Seattle and Denver clients before
3. A simple approach is to split the $90 equally between the two clients. The limousine costs
at the Atlanta end are not a function of distance traveled on the plane.
a. Stand-alone cost allocation method.
b. Incremental cost allocation method.
With Seattle client as the primary party:
With Denver client as the primary party:
c. Shapley value.
As discussed in requirement 2, the Shapley value or the stand-alone cost allocation
method would be the preferred approaches.
Note: If any student in the class has faced this situation when visiting prospective employers, ask
them how they handled it.
15-25 Revenue allocation, bundled products. Couture Corp sells Samsung 7 cases. It has a
Men’s Division and a Women’s Division. Couture is now considering the sale of a bundled
product called Dynamic Duo consisting of Smarty, a men’s case, and Sublime, a women’s case.
For the most recent year, Couture sold equal quantities of Smarty and Sublime and reported the
following:
Required:
1. Allocate revenue from the sale of each unit of Dynamic Duo to Smarty and Sublime using
the following:
a. The stand-alone revenue-allocation method based on selling price of each product
b. The incremental revenue-allocation method, with Smarty ranked as the primary product
c. The incremental revenue-allocation method, with Sublime ranked as the primary product
d. The Shapley value method
2. Of the four methods in requirement 1, which one would you recommend for allocating
Couture’s revenues to Smarty and Sublime? Explain.
