Chapter 8 - Cost allocation: Practices. The main contents of the chapter consist of the following: Death spiral, death spiral example: internal services, death spiral example: cost-based contracts, death spiral in reverse, allocating capacity costs: depreciation, methods of service department allocation,. | Cost Allocation: Practices Chapter Eight Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Death Spiral Death spiral occurs when large fixed costs of a common resource are allocated to users who could decline to use that resource. As the allocated costs increase to the remaining users, some users choose to decrease use. Then the fixed costs are allocated to the remaining users, more of whom use less. This process repeats until no users are willing to pay the fixed costs. Possible solutions to death spiral: When excess capacity exists, charge users only for variable costs. Reduce the total amount of fixed costs allocated. 8- Death Spiral Example: Internal Services Internal Telecommunications Department: Telecommunications service department allocates fixed costs to users. If some users are allowed to switch to outside phone company, the fixed costs allocated to remaining users increase. Eventually, the number of users of the telecommunications department is so small that the department is closed. 8- Death Spiral Example: Cost-based Contracts Military Aircraft (not in text): Defense contractors working on advanced technology incur large fixed cost over-runs that are allocated to each aircraft manufactured. Government reduces number of aircraft purchased and that causes average cost to increase on remaining orders. Government responds by ordering even fewer aircraft. Eventually, the entire project is abandoned before all fixed costs are recovered. 8- Death Spiral in Reverse! Clay Sprays: Increasing the allocation base for fixed costs can lead to misleading product line profit figures. Decisions should be consistent with an overall economic strategy and a meaningful understanding of the impacts of accounting practices. “I left this to the accountants” would not cut it in today’s business environment. 8- Allocating Capacity Costs: Depreciation Accounting depreciation represents the annual historical cost of . | Cost Allocation: Practices Chapter Eight Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Death Spiral Death spiral occurs when large fixed costs of a common resource are allocated to users who could decline to use that resource. As the allocated costs increase to the remaining users, some users choose to decrease use. Then the fixed costs are allocated to the remaining users, more of whom use less. This process repeats until no users are willing to pay the fixed costs. Possible solutions to death spiral: When excess capacity exists, charge users only for variable costs. Reduce the total amount of fixed costs allocated. 8- Death Spiral Example: Internal Services Internal Telecommunications Department: Telecommunications service department allocates fixed costs to users. If some users are allowed to switch to outside phone company, the fixed costs allocated to remaining users increase. Eventually, the number of users of the .
