The incremental cost-allocation method ranks the individual users of a cost object in the order of users most responsible for the common cost and then uses this ranking to allocate cost among those users. The first-ranked user of the cost object is the primary user (also called the primary party) and is allocated costs up to the costs of the primary user as a stand-alone user. The second-ranked user is the first-incremental user (first-incremental party) and is allocated the additional cost that arises from two users instead of only the primary user. The third-ranked user is the second-incremental user (second-incremental party) and is allocated the additional cost that arises from three users instead of two users, and so on.
We illustrate this method for Jason Stevens and his $1,500 airfare cost. Assume the Albany employer is viewed as the primary party because Stevens’s had already committed to go to Albany before accepting the invitation to interview in Chicago. The cost allocations would be
The table depicts costs allocated and cumulative costs allocated for Albany and Chicago, as well as the total. The details of the table are as follows:
1. Albany, primary party
2. Chicago, incremental party
3. Total costs allocated: 1,500 dollars
The Albany employer is allocated the full Seattle–Albany airfare. The unallocated part of the total airfare is then allocated to the Chicago employer. If the Chicago employer had been chosen as the primary party, the cost allocations would have been Chicago $800 (the stand-alone round-trip Seattle–Chicago airfare) and Albany . When there are more than two parties, this method requires them to be ranked from first to last (such as by the date on which each employer invited the candidate to interview).
Under the incremental method, the primary party typically receives the highest allocation of the common costs. The difficulty with the method is that every user prefers to be viewed as the incremental party!
One approach to address this challenge is to use the Shapley value method, which considers each party as first the primary party and then the incremental party. From the calculations shown earlier, the Albany employer is allocated $1,200 as the primary party and $700 as the incremental party, for an average of The Chicago employer is allocated $800 as the primary party and $300 as the incremental party, for an average of The Shapley value method allocates, to each employer, the average of the costs allocated as the primary party and as the incremental party: $950 to the Albany employer and $550 to the Chicago employer.*
As our discussion suggests, allocating common costs is not clear-cut and can cause disputes. Whenever feasible, managers should specify the rules for such allocations in advance. If this is not done, then, rather than blindly follow one method or another, managers should exercise judgment when allocating common costs by thinking carefully about allocation methods that are fair to each party. For instance, Stevens must choose an allocation method for his airfare cost that is acceptable to each prospective employer and does not exceed the maximum reimbursable amount of airfare for either employer.