This blog walks through three alternatives for allocating central facilities cost to four departments. Facilities cost totals $100K and includes utilities, building maintenance, and all facilities related miscellaneous expenses.
The organization has five buildings as shown in the illustration’s first set of numbers. Department A has two buildings and the other departments have one each. How will the $100K be allocated is number of buildings became the basis of allocation?
Building on prior basic concepts the rate per building would be $20K per building. This is simply the total cost ($100K) divided by the number of buildings (5). Alternatively the proportions would be 40%, 20%, 20%, and 20% for the four departments. The resulting allocation would be:
Department A Department B Department C Department D Total
$40K $20K $20K $20K $100K
As a refresher consider that the cost pool is the $100K to be allocated. The basis of distribution is the number of buildings. The cost objects are the departments.
Allocation mechanics should be simple at this point. The challenge in choosing a basis of allocation lies in whether it meets user (manager) needs. If accurate reflection of facility costs is the goal, one might question the fitness of the number of buildings as the basis of allocation.
When choosing this basis we would be assuming that each building consumed the same amount of resources. This would clearly be untrue if one of the buildings was the Pentagon?
In this case we could visualize the manager of Department B raising objections. She says that her building is tiny compared to the other’s and the allocation is over charging her department.
She feels she is cross subsidizing the other departments and it appears to make her financial performance worse than it is. She proposes that square footage would more accurately represent her consumption and better reflect her true cost.
This brings up the opportunity to introduce another term: cost driver. A cost driver has a cause and effect relationship. Drivers are good choices because there is a correlation of consumption to driver and it certainly makes sense that larger building would drive more facilities cost. This is why square footage is a common basis of allocation for facilities related costs.
The square footage occupied by each department is determined and proves her correct as shown in the second set of numbers in the illustration. There is 50K square feet in total and she only occupies only 2% which means she would be allocated 2% instead of the 20%. The square footage based allocation yields:
Department A Department B Department C Department D Total
$40K $2K $18K $40K $100K
Note that the distribution changes significantly. D’s cost doubles. C gets a small reduction and B’s cost is cut by 90%. Note also that the total cost does not change. Allocation is a zero sum game. This means increases in one area are offset by decreases in another. Sometimes this is referred to as balloon squeezing because pushing on one side expands the other.
Is square footage then the “perfect” driver? There is no such thing. We are always making an assumption when choosing a basis of distribution and it may not be true that square footage reflects consumption. The manager of Department D thinks this is the case and points out that his building, while large, was not air conditioned unlike the others’.
It is certainly reasonable that his utilities cost would be substantially less. This situation requires the addition of another driver and the $100L cost pool must be divided into two pools: one for air conditioning related cost and one for the remaining cost.
Doing this finds $40K in air conditioning (A/C) related and $60K in the remaining (non A/C). Once we determine the air conditioned and non air conditioned square footage (see third set of numbers in the illustration) we can do the mechanics of allocation.
Department A Department B Department C Department D Total
Non A/C $24K $1.2K $10.8K $24K $60K
A/C $20K $2K $18K --- $40K
Total $44K $3.2K $28.8K $24K $100K
Note that the total didn’t change, of course, but the distribution has again significantly changed. This is now a better reflection of consumption but is still subject to assumptions. There is theoretically no limit to the number of pools and bases that could be added to the cost model. Practically, however, complexity stops when the drivers are reasonably reflective of sameness or homogeneity.
To summarize:
Number of Buildings is a good basis of allocation IF….
All buildings are the same
Square footage is a good basis of allocation IF….
All square feet are the same
Air conditioned footage and square footage are good methods IF….
All air conditioned square feet are the same and all square feet are the same
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