Assignment: Comparing Cost Allocation Methods
Walden University
Memorandum
To: Pamela Kirk, Accounting Manager
From: Donna N. Johnson
Date: March 29, 2019
Subject: Comparing Cost Allocation Methods
When allocating cost there are several methods Anthony’s Orchard can choose from. The purpose of this memo is to determine the best method to measure its performance and if the current methods reflect the true value and profitability of the business. Accountability is essential when making wise financial decisions. The direct, step down and reciprocal methods will be explained and analyzed below:
The direct allocation method is a simple method to allocate the cost of service to operating departments. Under this method, the costs incurred by service departments are not allocated to each other; rather, they are directly allocated to operating departments using some appropriate allocation base (Direct method of cost allocation, 2018).
Direct Allocation Method:
| Prepared Apples | Pick Your Own Apples | Community Events | Finance | Marketing | Executive Team | Technology | Procurement | Facilities | Administrative Budget | |
| Technology | $ 86,000.00 | $ 64,500.00 | $ 107,500.00 | $ 43,000.00 | $ 64,500.00 | $ 21,500.00 | $ – | $ 21,500.00 | $ 21,500.00 | $ 430,000.00 |
|---|---|---|---|---|---|---|---|---|---|---|
| Marketing | $ 90,000.00 | $ 90,000.00 | $ 120,000.00 | $ – | $ – | $ – | $ – | $ – | $ – | $ 300,000.00 |
| Executive Team | $ 90,000.00 | $ 60,000.00 | $ 75,000.00 | $ 15,000.00 | $ 15,000.00 | $ – | $ 15,000.00 | $ 15,000.00 | $ 15,000.00 | $ 300,000.00 |
| Finance | $ 26,250.00 | $ 87,500.00 | $ 17,500.00 | $ 8,750.00 | $ 8,750.00 | $ 8,750.00 | $ 8,750.00 | $ 8,750.00 | $ – | $ 175,000.00 |
| Facilities | $ 50,000.00 | $ 25,000.00 | $ 18,750.00 | $ 6,250.00 | $ 6,250.00 | $ 6,250.00 | $ 6,250.00 | $ 6,250.00 | $ – | $ 125,000.00 |
| Procurement | $ 22,500.00 | $ 22,500.00 | $ 11,250.00 | $ 3,750.00 | $ 3,750.00 | $ 3,750.00 | $ 3,750.00 | $ – | $ 3,750.00 | $ 75,000.00 |
The step-down allocation method procedure is sequential and requires the identification of the service department the provides the greatest amount of service to the other service departments and ends with the allocation of cost of the service department that provides the least amount of service to other service departments (Step down method of cost allocation, 2018).
| Technology | Marketing | Executive team | Finance | Facilities | Procurement | Prepaired Products | Pick your Own Apples | Community Events | |
| Costs prior to allocation | $ 430,000 | $ 300,000 | $ 300,000 | $ 175,000 | $ 125,000 | $ 75,000 | $ – | $ – | $ – |
|---|---|---|---|---|---|---|---|---|---|
| Allocation of Technology | $ 64,500 | $ 21,500 | $ 43,000 | $ 21,500 | $ 21,500 | $ 86,000 | $ 64,500 | $ 107,500 | |
| Allocation of Marketing | $ 364,500 | $ – | $ – | $ – | $ – | $ 109,350 | $ 109,350 | $ 145,800 | |
| Allocation of Executive Team | $ 321,500 | $ 17,861 | $ 17,861 | $ 17,861 | $ 107,167 | $ 71,444 | $ 89,306 | ||
| Allocation of Finance | $ 235,861 | $ 13,874 | $ 13,874 | $ 41,623 | $ 138,742 | $ 27,748 | |||
| Allocation of Facilities | $ 178,235 | $ 11,140 | $ 89,118 | $ 44,559 | $ 33,419 | ||||
| Allocation of Procurement | $ 139,375 | $ 55,750 | $ 55,750 | $ 27,875 |
The last method is the reciprocal method defined as a technique using simultaneous equations to allocate a manufacturer’s service departments’ cost to both other service departments and to production departments (Reciprocal method definition and meaning, n.d.). The cons of this method are calculation is time-consuming and complex out of them all and assumes all costs associated are variable, fixed cost should be included according to expected used. However, this method is considered the most accurate when distributing costs and measures closets to opportunity costs.
In closing my suggested method would be to use the direct cost allocation. This method is not only easy to understand and calculate, implementation will not be a problem. Direct method is one of several cost allocation methods to assign indirect costs to cost objectives (Bank, 2017). This method will fully allocate all overhead costs from the service departments to the prepared apple production inventory, community events, and pick your own products.
Reference:
Bank, E. (2017, November 21). The Advantages of the Direct Method of Cost Allocation. Retrieved March 29, 2019, from https://smallbusiness.chron.com/advantages-direct-method-cost-allocation-66081.html
Direct method of cost allocation – explanation, example, advantages and disadvantages. (2018, August 12). Retrieved March 29, 2019, from https://www.accountingformanagement.org/direct-method-of-cost-allocation/
Reciprocal method definition and meaning | AccountingCoach. (n.d.). Retrieved March 29, 2019, from https://www.accountingcoach.com/terms/R/reciprocal-method
Step down method of cost allocation – explanation, example, advantages and disadvantages. (2018, June 13). Retrieved March 29, 2019, from https://www.accountingformanagement.org/step-method-of-cost-allocation/
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