Question

You neighbor friend Ann and you attend the MBA Program in Professional Accounting. Both of you live a few blocks apart, and have the same course schedule. You offer her daily ride in your car to school. Ann offers to share in the cost. You incur the following costs: Depreciation Amortization Insurance Gasoline Tolls Parking The conversation between you two runs as follows. Ann: “Thanks for offering me a ride. It’s great, but please let me share in the cost.” You: “Forget it. It’s my pleasure. I go anyway, so there’s is no extra costs.” Ann: “Come on, I feel bad being a free rider. Let’s just allocate the cost of the trips.” You: “Believe me Ann, even if I wanted to allocate I wouldn’t know how.” Ann: “We are to be accountants. We should know how to fully allocate costs.” You: “In this case we should allocate incrementally, not fully.” Ann: “Now you are talking like an economist, not like an accountant.” You: “This is too complicated Ann. Why don’t you just buy me a coffee now and then?” Ann: “Please, I insist on sharing.” You: “I already did an incremental allocation, and your perfectly fair share is zero, but I want you to feel good, so here is the deal. If you can come up with a more reasonable cost allocation, I’ll go along.” 1. Can you come up with a “more reasonable” cost allocation? 2. Discuss the implications of the above for costing business by-products or by-services.

Answer 1

In this case the costs can be divided in two parts;

1] Daily operating cost (Direct costs) - Gasoline, Tolls & Parking

2] Maintenance cost (Indirect costs) - Depreciation, Amortization & Insurance

Daily operating cost can be divided among two on 50-50 basis as those are incurred when the car is being used for the ride.

Maintenance cost can be apportioned on the basis distance covered for college. Eg. Total indirect cost = $10,000 per annum

Total distance covered daily basis for college - 10 miles

No. of days in a year traveled to college - 240 days

Total distance covered in a year - 240*10 = 2400 miles

Total distance covered by the car in a year - 5000 miles

The indirect cost to be apportioned for college trips will be - 10,000*2,400/5,000 = $4,800

$4,800 can be divided 50-50 basis between two of them.