Learning Objective 4 Allocate common costs using the stand-alone method and the incremental method
Management accountants must sometimes allocate common costs. A common cost is the cost of operating a facility, activity, or cost object when that facility, activity, or cost object is shared by two or more users. Common costs arise because each user incurs a lower cost by sharing a facility or activity than operating the facility or performing the activity independently. The cost accounting challenge is how to allocate common costs to each user in a reasonable way.
Consider Jason Stevens, a graduating senior in Seattle who has been invited to a job interview with an employer in Albany. The round-trip Seattle–Albany airfare costs $1,200. A week later, Stevens is also invited to an interview with an employer in Chicago. The Seattle–Chicago round-trip airfare costs $800. Stevens decides to combine the two recruiting trips into a Seattle–Albany–Chicago–Seattle trip that will cost $1,500 in airfare. The prospective employers will reimburse Stevens for the airfare. The $1,500 is a common cost that benefits both prospective employers because it is less than the that the employers would have to pay if Stevens interviewed with them independently.
How should Stevens allocate common costs of $1,500 to the two employers? Two methods of allocating common costs are the stand-alone method and the incremental method.
The stand-alone cost-allocation method determines the weights for cost allocation by considering each user of the common cost facility or activity as a separate entity. For the common-cost airfare of $1,500, information about the separate (stand-alone) round-trip airfares ($1,200 and $800) is used to determine the allocation weights:
Advocates of this method often emphasize the fairness or equity criterion described in Exhibit 14-1. The method is viewed as reasonable because each employer bears a proportionate share of total costs in relation to the individual stand-alone costs.