Question

14-29 Common costs. Ransom Inc. and Downey Inc. are two small clothing companies that are consider- ing leasing a dyeing machine together. The companies estimated that in order to meet production, Ransom needs the machine for 900 hours and Downey needs it for 600 hours. If each company rents the machine on its own, the fee will be $40 per hour of usage. If they rent the machine together, the fee will decrease to $32 per hour of usage.

Required

1. Calculate Ransom’s and Downey’s respective share of fees under the stand-alone cost allocation method.

2. Calculate Ransom’s and Downey’s respective share of fees using the incremental cost allocation method. Assume Ransom to be the primary party.

3. Which method would you recommend Ransom and Downey use to share the fees?

Answer 1

1)	Cost Allocation by Strand alone cost allocation method
	Standalone Cost
	Ransom Inc	(900*40)	36000
	Dawney Inc	(600*40)	24000
	Total Cost		60000
	%of cost of Ranson Inc	(36000/60000)*100)	60%
	%of cost of Dawney Inc	(24000/60000)*100)	40%
	Discounted Cost	(1500 Hours*32)	48000
	Statement of Cost Allocation by Standalone cost allocation method
	Share of Cost by Ransom Inc	(48000*60%)	28800
	Share of Cost by Dawney Inc	(48000*40%)	19200
	Total Cost		48000
	Notes
	1) Discount of $ 12000 will be distributed amonst both the parties in the ratio of standalone expense. Both of them will now pay a lesser amount in comparison to amount which they were suppose to pay standalone.

2)	Cost Allocation by Incremental cost allocation method
	Primary Party/user                                                        =	Ransom Inc
	Secondary user/first Incremental user                      =	Downey Inc
	Total Cost Discounted cost	(A)	48000
	Share of Ransom Inc	(B)	36000
	Share of Dawney Inc	(C=A-B)	12000
	Notes
	1) When we use Incremental cost allocation method then the primary user will not get any benefit of discount and will be the cost which he was suppose to pay standalone.
	2)Full discount amount will be used by Downey Inc.

3)	Recommendation for Random Inc
	Ransom should use Standalone cost allocation method as he will have to pay less in comparison to Incremental cost allocation method
	Recommendation for Downey Inc
	Downey Inc should use Incremental cost allocation method if he is secondry user.