Question

Why does allocating freight expenses based on the quantity sold a reasonable choice?

How does the allocation method impact projected rent expense4, salary expense, and

advertising expense? Which method is the fairest? Would you recommend that the

company use a single or multi-driver allocation method? Why?

(Freight cost is allocated based on quantity sold all other indirect expenses could be allocated evenly across the stores, by the square footage, or by the quantity of bottles sold )

Answer 1

Hey,

Certain Expenses are directly related to production like raw material cost or freight cost as per your question. More you produce more the freight cost will be incurred and vice versa.

While certain expenses are not related to production like rent, salary of staff(not workers because workers salary is related to production) & advertisement this expenses are general in nature, even if production is stoped compeletely, still Rent is to be paid compulsory staff salary is to be paid.

No Method could be said fairest in general because depending on type of industry method of allocation is to be selected. for example if company produces car it can allocate freight per unit, but if company is manufacturing minute items like nails(used in furniture) then they cant allocate freight expense to individual product.

Multi Driver Allocation Method is much more adviceable because it gives fair view of costs incured as compared to single allocation. lets take an example of Rent, say rent per month is 10000 so for full year rent is 120000. Also say company produced 120000 units so as per unit allocation you can say 1$ Per unit is rent, but what if for first 3 months of a year no production was done then will you not charge rent for those 3 months ?? (you have to pay rent for 3 months)

Thus using multi-drivers for allocating different expenses is recommended as it gives fair presentation.