1. W. BentzA&MIS 5251 It’s great to see the focus on activity costing, but they are still missing the point! _George Staubus Today’s Quote

2. W. BentzA&MIS 5252 Agenda for Session 11 Review the motivation for cost allocation Review the criteria used to allocate cost in the US today Outline some of the methods we have used or will use in this class. Illustrate the opportunity to influence costs using the step-method. Discuss case assignment

3. W. BentzA&MIS 5253 Motivation for Cost Allocation Provide unbiased information for economic decisions –Management planning & control –Operating control Example: Prairie State Case Example: Nebraska Social Services Example: Canadian Air Force

4. W. BentzA&MIS 5254 Motivation for Cost Allocation Incent managers and employees –Financial plans & incentives –Feedback & scorekeeping –Aware of cost impacts of activities –A fundamental issue in this context is to attribute costs, revenues, cash flows, and investment to the responsible entities and individuals

5. W. BentzA&MIS 5255 Motivation for Cost Allocation Implement agreements –Cost sharing (joint ventures) –Cost reimbursement (programs, activities) –Cost-plus pricing (various contracts) Determine, justify and defend actions –Price discrimination lawsuits –Regulated industries –Antitrust proceedings

6. W. BentzA&MIS 5256 More Objectives Financial, tax, and regulatory reporting requirements: –Quarterly reports to shareholders –Quarterly reports to creditors (if not more frequent) –Regulatory reports –Tax payment timing –Budget realization

7. W. BentzA&MIS 5257 Cost Allocation In many settings, the manner in which costs are allocated can have a significant impact on the apparent success of projects, departments, programs, products, services, and managers. It is both an intra-firm issue and an inter-firm one.

8. W. BentzA&MIS 5258 Criteria Used to Allocate Costs Economic validity –Search for cause-effect relationships based on actual data –Find the more important cost drivers based on actual data

9. W. BentzA&MIS 5259 Another Criterion Benefits received –Use of common facilities Utilization of common facilities Products or services received –Use of resources or creation of liabilities Billings for services rendered per agreement or letter of engagement

10. W. BentzA&MIS 52510 More Criteria Fairness or equity –Implementation of an agreement –Appropriate in uncertain environments –Can reduce the risk premium Ability to pay –May or may not be “fair” –Joint product costing is a good example –Allocation of corporate expenses

11. W. BentzA&MIS 52511 Fundamental Questions? Validity of the results in an economic, accounting sense Understandability by users Perceived fairness of the results Usefulness to customers of the information Impact on the system (firm, economy, other)

12. W. BentzA&MIS 52512 Types of Costs Involved Variable costs (materials in joint processes) Capacity costs Common costs Joint purchases Costs shared by agreement

13. W. BentzA&MIS 52513 Allocation Methods Activity (ABC) rates to charge users Proportional usage as in matrix model Estimates of relative exit values Opportunity cost as in linear programming Game theoretic as in Shapely method

14. W. BentzA&MIS 52514 Changing Directions…..

15. W. BentzA&MIS 52515 Attributes of Support Activity Cost Allocation Models Direct allocation to production activities –unique answer –biased if any service relationships are ignored in the process –answer always exists and can be computed using general purpose software

16. W. BentzA&MIS 52516 Step or sequential method Answer is unique only when the activities are acyclic and the allocation incorporates all service relationships. Answer always exists to realistic problems. Specialized software is needed to determine if activities are acyclic and to put them in the proper sequence.

17. W. BentzA&MIS 52517 Reciprocal Method Answer is unique. Answer is unbiased. Answer to the allocation equations always exists. Allocations can be done with standard software packages.

18. W. BentzA&MIS 52518 Consider the Step-Method changing directions…. Hoosier industries problem from your packet.