Cost Allocation Method

Cost allocation is a method to determine the cost of services provided to users of that service. It does not determine the price of the service, but rather determines what the service costs to provide. It is important to determine the cost allocation of the services, in order to determine a justifiable fee/charge/tax for those services.

Included in cost allocation are direct, indirect, and incremental costs. Direct costs, or separable costs, are costs that are related to a single type of service and are related to one type of output or user such as, a sector-to-sector hand-off. Indirect costs, or common costs, are related to more than one type of service, such as, the physical en-route facility. Incremental costs change with the level of output produced. Incremental costs measure changes in output, e.g., differences in staffing levels or staffing costs at a facility that is based on traffic count.

Cost allocation is a factor that determines the cost of an activity. Cost drivers are analyzed as part of activity based costing and can be used in continuous improvement programs. They are usually assessed together as multiple drivers rather than singly. There are two main types of cost driver: the first is a resource driver, which refers to the contribution of the quantity of resources used to the cost of an activity; the second is an activity driver, which refers to the costs incurred by the activities required to complete a particular task or project.

We will answer the following questions from three different organizations:1)U.S. Army Corp of Engineer: Why does the US Army Corp of Engineers worry about cost allocations? Aren’t they a branch of the US Federal Government? Why does it matter whether or not costs are allocated?A)The reason U.S. Army Corp of Engineer conduct a Cost Allocation is to study a variety of possible approaches that could be used to distribute costs of the proposed alternatives. The primary purpose of allocating project costs is to identify repayment responsibility regarding cost recovery, cost sharing, or both. The Corps of Engineer used the approaches utilizing preliminary construction costs and the unrecovered Federal investment.

B)The U.S. Army Corp of Engineer is required to cost allocate funds for future projects that federal government will fund and it will be mitigate or by private sector. In another terms, after the federal government funds the projects and the mayor investor industries that do benefits from them will be responsible to repay that debt. In the case of U.S. Army Corps of Engineer, Walla Walla District, The Bonneville Power Administration is the responsible industry to re-pay the debt to the federal government.

2)The City of Seattle reading lists a series of costs and associated cost drivers for allocating these costs. Do you agree with the cost drivers (cost allocation factors)? Do you agree with the cost drivers (cost allocation factors)? Does it make sense to have all of these individual costs and drivers identified or should there be a more uniform method of allocating costs? Why do they allocate costs anyway in a government (City Government) setting — aren’t cost allocation methods mostly for manufacturing companies?A)Do you agree with the cost drivers (cost allocation factors)? Yes, I do agree with the costs drivers, it is obvious that many State Department has many sub-departments. Therefore, it is necessary to re-distribute cost and allocate cost base on historical cost and any other circumstances necessary for any additional cost projected for the new fiscal year.

B)Do you agree with the cost drivers (cost allocation factors)? Does it make sense to have all of these individual costs and drivers identified or should there be a more uniform method of allocating costs? To my understanding, the drivers selected, came from the sub-division of every State Departments. It is necessary to hold every Department and sub-department accountable for respective spending and been uniformly auditable independently.

C)Why do they allocate costs anyway in a government (City Government) setting — aren’t cost allocation methods mostly for manufacturing companies? Cost allocating is used in sectors, private and governments, clearly in two different ways. In fact most of the Universities divide both in two different classes. Government accounting and Manufacturing Accounting. In the Manufacturing sector, cost allocation accounting can be used in different manners; Companies allocate costs so that all elements that are part of that cost share the incurred costs. It is like spreading the costs amongst those that use it. Companies allocate costs merely to assign responsibility of those costs to either several departments within that company or to just one department.

3)Why does the US Department of Human Services have a special division just for Cost Allocation? What are some of the ways in which they administer cost allocation for hospitals, colleges, and non-profit organizations?A)The Division of Cost Allocation (DCA) provides negotiation services for indirect cost rate proposals and cost allocation plans. For more than 50 years, DCA has reviewed cost allocation methods and practices of entities that receive Federal funds, helping to ensure that indirect costs paid by the FederalGovernment are fair, equitable, and in accordance with Federal regulations. (http://www.psc.gov/directory/2009directory.pdf).

Some ways in which DHHS administer cost allocation are as follow in according to federal regulation:1)Colleges and Universities- If a cost benefits two or more projects or activities in proportions that can be determined without undue effort or cost, the cost should be allocated to the projects based on the proportional benefit. If a cost benefits two or more projects or activities in proportions that cannot be determined because of the interrelationship of the work involved, then, notwithstanding subsection b, the costs may be allocated or transferred to benefit a project on any reasonable basis, consistent with subsections d.(1) and (2). (Circular No. A-21(c), (d) (2))2)Hospitals- Each hospital, possessing its own unique combination of staff, facilities and experience should be encouraged to conduct a research in a manner consonant with its own Institutional philosophies and objectives. Each hospital in the fulfillment of its contractual obligations should be expected to employ sound management practices.

The application of the principles established herein shall be in conformance with the generally accepted accounting practices. (45 CFR Subtitle A (10 9 Edition, Pt.74, App. E)4) Nonprofit organizations- A cost is allocable to a particular cost objective, such as a grant, contract, project, service, or other activity, in accordance with the relative benefits received. A cost is allocable to a Federal award if it is treated consistently with other costs incurred for the same purpose in like circumstances and if it:(1) Is incurred specifically for the award.

(2) Benefits both the award and other work and can be distributed in reasonable proportion to the benefits received, or(3) Is necessary to the overall operation of the organization, although a direct relationship to any particular cost objective cannot be shown.

Any cost allocable to a particular award or other cost objective under these principles may not be shifted to other Federal awards to overcome funding deficiencies, or to avoid restrictions imposed by law or by the terms of the award. (CIRCULAR NO. A-122)In conclusion: Is cost allocation only relevant for government agencies like those above? Why or why not?Cost allocation is relevant to both government and retail industry as well. They both have their noticeable differences in many cases, but not in all. There are government offices that are sustainable on their own revenue, such as the department of motor vehicle, and others. However, there are others government offices whom are strictly services offices in which need government allocation to sustain their operations. Such offices are measured based on their efficiency and customer service to the public to maintain politicians word to their constituents.

One of the examples is the Social Security Administration (SSA). The SSA, although, it has his own trust fund, it is also measured by the among of disability claim that it process and the time frame that take a claim to be process, from start to finish. The SSA is also measured on it efficiency by the waiting period the claimants/ customers are waiting in the reception before a Service Representative call their number. Cost allocation it is also used by the government to allocate funds of projects and to identify non-government investors recovery debts.

Cost allocations is a great tool to account for an unaccountable cost related in the retail business. Un-expected expenses or unaccountable expenses to either allocate them to specific operation in which the cost can be identify or re-distributed, the cost either equitably or non-equitably across the organization. One issue, managers should be careful is not tie imposed cost to specific operation and judge their efficiency based on non-controllable cost imposed by the accounting department.

A great example can be a chain of stores in three different location, producing the same revenue and distribute the un-accountable cost to a 50% store #1, 25% store #2 and 25% store #3. Clearly the performance of store #1 will be less than the other two stores, but for whatever reason, taxes, or other reason, we allocated 50% to store #1, this action cannot be taken in consideration to measure the store抯 ability to produce or the Management in charge of running the store. Those costs should be omitted, when conducting a store performance evaluation.

References:

Department of Human Health Service web site, retrieved from: http://eclkc.ohs.acf.hhs.gov/hslc/Program%20Design%20and%20Management/Fiscal/Narrative%20Discussions/Cost%20Allocation.htm, on November 28, 2009.

Department of Human Health Service web site, retrieved from: http://www.hhs.gov/opa/espanol/grants/toolsdocs/45cfr74.pdf, on November 28, 2009.

White House web site, retrieved from: http://www.whitehouse.gov/omb/rewrite/circulars/a122/a122.html, on November 28, 2009.

White House web site, retrieved from:http://www.whitehouse.gov/omb/rewrite/circulars/a021/a021.html, on November 28, 2009.

US Army Corps of Engineers – Walla Walla Project retrieved from: http://www.nww.usace.army.mil/lsr/reports/misc_reports/allocate.htm, on
November 22, 2009.

City of Seattle Budget for 2009 – 2010 retrieved from: http://www.cityofseattle.net/financedepartment/0910adoptedbudget/Cost_Allocation_2009_Adopted_and_2010_Endorsed_Budget.pdf, on November 22, 2009.