1. Distribute Single Cost Pool to Users
Principles of Cost Analysis and Management

2. Have you ever been here?

3. Terminal Learning Objective
Action: Allocate Single Cost Pool to Users
Condition: FM Leaders in a classroom environment working as a member of a small group, using doctrinal and administrative publications, self-study exercises, personal experiences, practical exercises, handouts, and discussion
Standard: With at least 80% accuracy (70% for international Learners) you must:
Explain how poor cost information encourages undesired behaviors
Calculate driver rate and proportion

4. A Broad Definition of Managerial Costing
raw accounting data
managerial
costing
translation
managerially useful information

5. Why Is This Translation Needed?
Accounting Systems usually measure input or source costs
Labor, overhead, materials
Salaries, benefits, supplies, contracts
Managers want measurements based on output or consumption
Product, service, project
Consuming organization, customer

6. Managerial Costing Terms
cost pool
raw accounting data
managerial
costing
translation
method of
distribution =
cost object
managerially useful information

7. Terminology
Cost pool - An aggregation of incurred costs (as measured by the accounting system) which must be distributed or assigned to cost objects.
Examples:
- Salary and benefits, supplies, travel, etc. in an airfield operations center
- Utility bills for a garrison
Method of distribution - the mechanics of deriving management information from the cost pool. The source costs in the cost pool will be assigned or distributed to cost objects, those views of cost that are useful to management.
Example:
- Determine unit cost by adding all input costs and dividing by number of units.
Cost Object - A view of cost needed by management
- 120mm tube product cost
- Morale, welfare, recreation cost
- Armor school cost

8. What is Allocation? Allocation: Example:
A method of distribution that distributes cost pool to cost objects in the same proportion as cost driver
Example:
Distributing the cost of utilities to occupants in the same proportion as space occupied
allocation
based on
cost driver

9. The Mechanics of Allocation
Allocation is a basic technique of activity based costing (ABC)
Becoming an expert is required but easy
Allocation mechanics excel spreadsheet makes it even easier
allocation
based on
cost driver

10. Two Allocation Methods
Rate Method:
Uses a computed rate per driver unit
Proportion Method:
Computes a proportional share of the total cost based on driver usage
Both Methods
Yield same results
Represent the same underlying algebra

11. Reconciling the Two Methods
Rate
Method
Total Cost Pool
Total Number of Driver Units
* Number of Driver Units Used
Equals
Proportion
Method
Number of Driver Units Used
Total Number of Driver Units
* Total Cost Pool
Equals
Number of Driver Units Used * Total Cost Pool
Total Number of Driver Units

12. Reconciling the Two Methods
Rate
Method
Total Cost Pool
Total Number of Driver Units
* Number of Driver Units Used
Equals
Proportion
Method
Number of Driver Units Used
Total Number of Driver Units
* Total Cost Pool
Equals
Number of Driver Units Used * Total Cost Pool
Total Number of Driver Units

13. Split the Dinner Check Total $160.00 Carol Alice Thank You Bob Ted
Chez Paris
Fillet and Lobster
Chicken Kiev
Top Sirloin
Caesar Salad
Coffee
House Wine
Champagne
Ice Cream
Chocolate Cheesecake
Sampler
Soup/Salad
Aperitif
Total $160.00
Carol
Alice
Thank You
Bob
Ted

14. Identifying Key Information
What is the cost pool? -
The dinner check of $160
What are the cost objects?
Bob, Carol, Ted and Alice
What is the cost driver?
What is the cost pool?
- The dinner check of $160
The dinner check of $160
What are the cost objects?
- Bob, Carol, Ted, and Alice
Bob, Carol, Ted and Alice
What is the cost driver?
- Number of persons (or eaters)

15. Allocation Mechanics.xls

16. Allocation by Rate Method
First, calculate the driver rate:
Total cost pool
Total driver units
Cost pool = $160
Total driver units = 4 eaters
Rate = $40/eater
Cost pool = $160
Total driver units = 4 eaters
Rate = $40/eater

17. Allocation by Rate Method (Cont.)
Second, multiply by driver units used by each cost object:
Bob = 1 eater * $40/eater = $40
Carol = 1 eater * $40/eater = $40
Ted = 1 eater * $40/eater = $40
Alice = 1 eater * $40/eater = $40
What if Bob and Carol are a couple and Bob is paying for them both?
Bob = 1 eater * $40/eater = $40
Carol = 1 eater * $40/eater = $40
Ted = 1 eater * $40/eater = $40
Alice = 1 eater * $40/eater = $40
What if Bob and Carol are a couple and Bob is paying for them both?

18. Allocation by Rate Method (Cont.)

19. Allocation by Proportion Method
First, calculate each cost object’s proportion:
Driver units used
Total driver units
Bob = 1 eater/4 eaters = 25%
Carol = 1 eater/4 eaters = 25%
Ted = 1 eater/4 eaters = 25%
Alice = 1 eater/4 eaters = 25%
Bob = 1 eater/4 eaters = 25%
Carol = 1 eater/4 eaters = 25%
Ted = 1 eater/4 eaters = 25%
Alice = 1 eater/4 eaters = 25%

20. Allocation by Proportion Method (Cont.)
Second, multiply each cost object’s proportion by total cost pool
Bob = 25% * $160 = $40
Carol = 25% * $160 = $40
Ted = 25% * $160 = $40
Alice = 25% * $160 = $40
What if Bob and Carol are a couple and Bob is paying for them both?
Bob = 25% * $160 = $40
Carol = 25% * $160 = $40
Ted = 25% * $160 = $40
Alice = 25% * $160 = $40
What if Bob and Carol are a couple and Bob is paying for them both?

21. Allocation by Proportion Method (Cont.)

22. The Results

23. LSA #1 Check on Learning
Q1. What is the rate per hour when the cost pool totals $30,000 and the total hours are 500?
A1.
Q2. One of the cost objects uses 50 hours or resources from the cost pool described above. What is its proportion?
A2.
Show Slide #23: LSA#1 Check on Learning
Facilitator’s Note: Ask the following Questions; (Facilitate discussion on answers given)
Q1.What is the rate per hour when the cost pool totals $30,000 and the total hours are 500?
A1. $30,000/500 hours = $60/hour
Q2. One of the cost objects uses 50 hours or resources from the cost pool described above. What is its proportion?
A2. 50 hours/500 hours = 10%

24. LSA #1 Summary
During this block, we discussed the rate and proportion methods. Each method results in the same manner when applied. We also defined key cost terminology and their importance in determining which allocation method to use.

25. Cross Subsidization Consumption Cost allocation
Is This Fair?
Consumption Cost allocation
Consumption Cost allocation

26. Incremental Effects What Happens if Bob Spends $10 More?90 80 70 60
Original 50 40
Incremental
Change 30 20 10
Bob Consumes
Bob Pays

27. Incremental Effects What Happens if Bob Spends $10 Less?80 70 60
Decreased
Amount 50
Bob’s Actual
Consumption And Payment 40 30 20 10
Bob Consumes
Bob Pays

28. Allocation: a Zero-Sum Game
The Total is Constant
Changing allocation basis simply redistributes cost
Increased Allocation for One Cost Object
Decreases the allocation for other cost objects
Sometimes called “Balloon Squeezing” or “Peanut Butter Effect”

29. Measurement Effects Motivation
Managerial costing inevitably impacts behavior
Design of managerial costing systems must recognize and anticipate this effect
Consider in this example
What incentives exist to spend more?
What incentives exist to spend less?
What would you do if you went to dinner with them tonight?

30. LSA #2 Check on Learning
Q1. Why did allocation based on number of eaters fail to reflect resource consumption?
A1.
Q2. What are the effects of incorrect allocation?
A2.
Show Slide #30: LSA#2 Check on Learning
Facilitator’s Note: Ask the following Questions; (Facilitate discussion on answers given)
Q1. Why did allocation based on number of eaters fail to reflect resource consumption?
A1. Allocation based on number of eaters failed to reflect resource consumption because the cost driver “number of eaters” does not reflect consumption.
- This problem, while illustrating the mechanics of allocation, does not reflect true consumption.
Q2. What are the effects of incorrect allocation?
A2. Unfair cross-subsidizations, the creation of almost free incremental goods, dysfunctional behavioral motivation
Q3. What might be a better method of allocation in the dinner check case?
A3. Detailed record keeping may be best in this problem --i.e. separate checks
Q3. What might be a better method of allocation in the dinner check case?
A3.

31. LSA #2 Summary
When we chose which allocation method to use, we are able to identify and cross subsidization between cost objects. This could potentially create undesired behaviors due to the incremental effects of the measurement.

32. TLO Summary Action: Allocate Single Cost Pool to Users
Condition: FM Leaders in a classroom environment working as a member of a small group, using doctrinal and administrative publications, self-study exercises, personal experiences, practical exercises, handouts, and discussion
Standard: With at least 80% accuracy (70% for international Learners) you must:
Explain how poor cost information encourages undesired behaviors
Calculate driver rate and proportion

33. Practical Exercises