Chapter 12, Problem 40E

Alternative Allocation Bases

Thompson Aeronautics repairs aircraft engines. The company’s Purchasing Department supports its two departments, Defense and Commercial. The Defense division has contracts with the Department of Defense and the Commercial division works primarily with domestic airlines and air freight companies. The cost of the Purchasing Department is $6 million annually.

Information on the activity of the Purchasing Department for the last year follows:

Required

1. a.      What is the cost charged to each division if Thompson allocates Purchasing Department costs based on the number of purchase orders?
2. b.      What is the cost charged to each division if Thompson allocates Purchasing Department costs based on the dollar amount of the purchases?
3. c.       Contracts with the Defense Department are on a cost-plus fixed fee basis, meaning the price is based on the cost of repairing an engine, including any overhead assigned to the division. Contracts with commercial airlines and air freight companies are almost all fixed price, meaning the price does not depend directly on the cost. Will this affect Thompson’s choice of an allocation base? Should it?