PROBLEM 66 Allocating Service Department Costs LO 1 World Ai

PROBLEM 6-6. Allocating Service Department Costs [LO 1] World Airlines has three service departments: (1) ticketing, (2) baggage handling, and (3) engine maintenance. The service depart ment costs are estimated for separate cost pools formed by department and are allocated to two revenue-producing departments: (1) domestic flights and (2) international flights. World does not differentiate between fixed and variable costs in making allocations. The following data relate to the allocations: Budgeted Data Costs Air Miles Ticketing Baggage handling Engine maintenance Domestic flights International flights $4,000,000 $2,000,000 $9,000,000 7,500,000 22,500,000 REQUIRED a. Allocate the service department costs to the revenue-producing departments using air miles as the allocation base. b. Evaluate the cause-and-effect relationship resulting from the use of air miles as the allocation base. In which of the cost pools do you think the cause-and-effect relationship is the strongest? Suggest alternative allocation bases for the two remaining cost pools with the weakest cause-and- effect relationship.

Solution

(a) Domestic flights= 7500000

International flights = 22500000

Total air miles = Domestic + international

So, 7500000+22500000 = 30000000

Total air miles = 30000000

Service department total cost = Ticketing + Baggage handling+ engine maintenance

Ticketing = 4,000,000

Baggage handling = 2,000,000

Engine maintenance = 9,000,000

4,000,000+2,000,000+9,000,000 = 15,000,000

Service department total cost = 15,000,000

Cost allocated to the domestic = (Service department total cost*domestic flight air miles)/ Total air miles

= (15,000,000 * 75,00,000)/30000000

= 3750000

Cost allocated to international flight = (Service department total cost*International flight air miles)/ Total air miles

                                                                                                         

= (15,000,000*22500000)/30000000

= 11250000

(b) Only the engine maintenance cost would have the strong effect on the air miles

Ticketing and baggage handling would not have a strong cause and effect in the air mile.

An alternative way will be:

In ticketing: Ticket should be sold on the base of class and no of ticket sold

In baggage: Baggage cost should be allocated based on the number of baggage.