Finance Allocation Exercises
EXERCISE 1
The building maintenance department for Taylor Bath Manufacturing Company budgets annual costs of $3,000,000 based on the expected operating level for the coming year. The costs are allocated to two production departments. Taylor Bath is considering two allocation bases for assignment of costs to departments: (1) square footage and (2) direct labor hours. The following data relate to the potential allocation bases:
Production Dept. 1 Production Dept. 2
Square Footage 20,000 30,000
Direct Labor Hours 30,000 20,000
Calculate the costs allocated to the production departments using each allocation base. Comment on which allocation base is preferable.
Solution:
Square Footage as an Allocation Base
Production Department 1
= (20,000/50,000) x $3,000,000
= $1,200,000
Production Department 2
= (30,000/50,000) x $3,000,000
= $1,800,000
Direct Labor Hours as an Allocation Base
Production Department 1
= (30,000/50,000) x $3,000,000
= $1,800,000
Production Department 2
= (20,000/50,000) x $3,000,000
= $1,200,000
Which allocation base is preferable?
As indicated, the choice of the allocation base greatly affects the allocations of cost. Use of square footage as the allocation base assigns 60% of the cost to department 2 and 40% to department 1. However, use of direct labor hours allocates 60% of the cost to department 1 and only 40% to department 2. Department 1 would prefer to be allocated cost based on square footage and department 2 would prefer direct labor hours as the base.
An allocation base that results in a cause and effect allocation is preferred. If maintenance costs are mostly related to building maintenance, then square footage is more likely to result in a cause and effect allocation. However, if maintenance costs are mostly made up of machine maintenance, then machine hours might be a better allocation base.
EXERCISE 2
Power
The building maintenance department for Taylor Bath Manufacturing Company budgets annual costs of $3,000,000 based on the expected operating level for the coming year. The costs are allocated to two production departments. Taylor Bath is considering two allocation bases for assignment of costs to departments: (1) square footage and (2) direct labor hours. The following data relate to the potential allocation bases:
Production Dept. 1 Production Dept. 2
Square Footage 20,000 30,000
Direct Labor Hours 30,000 20,000
Calculate the costs allocated to the production departments using each allocation base. Comment on which allocation base is preferable.
Solution:
Square Footage as an Allocation Base
Production Department 1
= (20,000/50,000) x $3,000,000
= $1,200,000
Production Department 2
= (30,000/50,000) x $3,000,000
= $1,800,000
Direct Labor Hours as an Allocation Base
Production Department 1
= (30,000/50,000) x $3,000,000
= $1,800,000
Production Department 2
= (20,000/50,000) x $3,000,000
= $1,200,000
Which allocation base is preferable?
As indicated, the choice of the allocation base greatly affects the allocations of cost. Use of square footage as the allocation base assigns 60% of the cost to department 2 and 40% to department 1. However, use of direct labor hours allocates 60% of the cost to department 1 and only 40% to department 2. Department 1 would prefer to be allocated cost based on square footage and department 2 would prefer direct labor hours as the base.
An allocation base that results in a cause and effect allocation is preferred. If maintenance costs are mostly related to building maintenance, then square footage is more likely to result in a cause and effect allocation. However, if maintenance costs are mostly made up of machine maintenance, then machine hours might be a better allocation base.
EXERCISE 2
Power