Question

Objectives of Cost Allocation Dr. Fred Poston,"Dermatologist to the Stars," has a practice in southern California. The practice includes three dermatologists, three medical assistants, an office manager, and a receptionist. The office space, which is rented for $5,000 per month, is large enough to accommodate four dermatologists, but Dr. Poston has not yet found the right physician to fill the fourth spot. Dr. Poston developed a skin cleanser for his patients that is nongreasy and does not irritate skin that is still recovering from the effects of chemical peels and dermabrasion. The cleanser requires $0.50 worth of ingredients per eight-ounce bottle. A medical assistant mixes up several bottles at a time during lulls in her schedule. She waits until she has about 15 minutes free and then mixes 10 bottles of cleanser. She is paid $2,250 per month. Dr. Poston charges $5.00 per bottle and sells approximately 5,000 bottles annually. His accountant is considering various ways of costing the skin cleanser. Required: 1a. Select the correct reasons for allocating overhead cost to the cleanser. a. To value inventory. b. To determine profitability. c. To plan sales and costs for the coming year. d. To motivate managers. e. To predict the economic effects of planning and control. 1b. How should the cost of the office space and the medical assistant’s salary be allocated to the cleanser? Explain. As long as he sells relatively few bottles of cleanser, it necessary to allocate any indirect costs to the cleanser. The medical assistant paid the same amount whether she mixes the cleanser or not. The space used to store the cleanser materials is , and the incremental cost is zero. 2. Suppose that Healthy You magazine runs an article on Dr. Poston and his skin cleanser, which causes demand to skyrocket. Consumers across the country buy the cleanser via phone or internet order. Now, Dr. Poston believes that he can sell about 40,000 bottles annually. He can hire someone part time, for $1,000 per month, to mix and bottle the cleanser and to handle the financial business of the cleanser. An unused office and examining room can be dedicated to the production of the cleanser. Would your allocation choice for Requirement 1 change in this case? Explain.

Answer 1

1.a) Dr. Poston may allocate overhed cost (Rent) to the cleanser for various reasons:

a) To value inventory.

b) To determine profitability

c) To plan sales and cost for coming years.

b) It is not necessary to allocate any indirect cost to cleanser as long as he sells relatively few bottles of cleanser . The medical assistant is paid the same amount(i.e $ 2250) irrespective of bottles mixed or whether she mixes the cleanser or not. The space used to store the cleanser material is small and the incremental cost is zero.

2. The situation after the HealthYou Magazine article on Dr Fred have led to increase in annual sales. Now, Office Rent as well as new assistant's salary should be allocated to the cleanser. The office rent should be apportioned 3/4 to 3 doctors and 1/4 to cleanser bottling operation given that cleanser operation takes an office and an examining room. It could be argued that this overstates the allocation to cleanser since the unused office area other than the examination area could be considered as the common area for practising doctors and cleanse operation and such common area does not serve the cleanse operation. The common area could well be treated as waiting room area where receptionist takes calls and open mails for the cleanser project so that overstating rent may be easily adjustable . The cost per bottle be:

Particulars Amount($)

Material 0.50

Labour($1000*12/40000) 0.30

Office Rent[($5000*12)/4]/40000) 0.375

Total Cost $1.175