Advantages: (1) The dual-rate method guides department managers to make decisions that benefit both the organization as a whole and each department because it signals to department managers that variable costs and fixed costs behave differently. By charging the fixed costs of resources budgeted to be used by the operating departments as a lump sum, the dual-rate method succeeds in removing fixed costs from the operating department managers’ consideration when making marginal decisions to outsource services. Operating department managers will only use an external provider of material-handling services if it costs less than the $30 variable cost per hour charged by the Materials Management Department. The dual-rate method therefore avoids the potential conflict of interest that can arise under the single-rate method. (2) Allocating fixed costs based on budgeted usage helps user departments with both short-run and long-run planning because user departments know the costs allocated to them in advance. Companies commit to infrastructure costs (such as the fixed costs of a support department) on the basis of a long-run planning horizon; budgeted usage measures the long-run demands of the user departments for support-department services.
Disadvantages: (1) The dual-rate method requires managers to distinguish variable costs from fixed costs, which is often a challenging task. (2) The dual-rate method does not measure the cost of fixed support department resources actually used by operating departments because fixed costs are allocated based on budgeted rather than actual usage. For example, the Machining Department manager is allocated fixed costs of the Materials Management Department based on budgeted usage of 800 labor-hours even though the Machining Department actually uses 1,200 labor-hours. (3) Allocating fixed costs on the basis of budgeted long-run usage may tempt some managers to underestimate budgeted usage. Underestimating budgeted usage leads to lower allocation of fixed costs (assuming all other operating department managers do not similarly underestimate usage). If all user department managers underestimate usage, it will lead to Robinson underestimating total support department needs. To discourage such underestimates, companies reward managers who make accurate forecasts of long-run usage—the “carrot” approach. Other companies impose cost penalties—the “stick” approach—for underestimating long-run usage by charging a higher cost rate if an operating department exceeds its budgeted usage.