Pamela Bourjaily is a consultant. Two of Pam’s current projects have considerable overlap, meaning that the same background research benefits both projects. The first project, from Apollo Corporation, pays cost plus 50%. The second project, from Troy Brothers, pays cost plus 30%. Apollo is a longtime customer while Troy is a future prospect, which is part of the reason for the price break.
Pam estimates that she has spent $6,000 on travel, books, and databases for work that is common to both projects. She also provides the following additional data.
.:.
Required:
a. Calculate the cost allocated to the two clients using budgeted hours as the allocation basis. Repeat the exercise using Pam’s sales to the clients as the allocation basis and the clients’ annual sales as the allocation basis.
b. Advise Pam on the appropriate choice of an allocation basis.
SOLUTION:
a. The following table provides the required computations.
| Allocation Using Budgeted hours | Allocation Using Pam’s Sales | Allocation Using Client’s Sales |
|---|
| Step 1: Determine the allocation rate | Step 1: Determine the allocation rate | | |
| Total cost in cost pool | $6,000 | $6,000 | $6,000 |
| Denominator volume | 80 hours (40+40) | $125,000 (100,000+25,000) | $250 million (50m + 200m) |
| Rate per unit of cost driver | $75 per hour | $0.048/$ of Pam‘s sales to client | $24/million of client sales |
| Step 2: Determine the cost allocated to each client | Step 2: Determine the cost allocated to each client | Step 2: Determine the cost allocated to each client | |
| Apollo | $3,000 | $4,800 | $1,200 |
| Troy | $3,000 | $1,200 | $4,800 |
| Total allocated | $6,000 | $6,000 | $6,000 |
Notice that the cost allocated to each client differs markedly depending on the allocation basis chosen.
b.
Pam faces a sticky problem, with no obvious solution. The one thing that is clear is that she cannot double-bill her clients. That is, it would be unethical for Pam to charge both clients for the entire $6,000 cost of the common work. She must allocate this cost among the two clients.
However, there is no obvious allocation basis. All else being the same, Pam prefers to allocate more to Apollo as the choice increases her reimbursement. Pam’s likely goal of increasing her wealth and building a longer client list also push her in this direction. However, this action penalizes an existing client for a new one.
The “ability to bear” criterion suggests a greater allocation to Troy. However, neither company is likely to care much about a $6,000 cost. Ultimately, Pam has to make a subjective decision about the choice for an allocation basis. An equal split seems as good as any other choice. Moreover, such a split is easy to explain and is a defensible action, should a client challenge the cost.