Complex Cost Allocation Problems And Contemporary Electronic Spreadsheet Technology

Abstract

Despite the observation that the reciprocal method produces more accurate service department cost allocations, many cost accounting textbooks continue to emphasize the direct method and the step method. Similarly, the direct method and the step method appear to be the dominant approaches used in practice. It has been conjectured that these methods are popular because they are easier to apply. This paper uses an easy-to-use optimizer included in electronic spreadsheets to make the case that ease of use may no longer be an acceptable reason for under-emphasizing the reciprocal method in cost and management accounting textbooks. The paper shows how complex cost allocation problems may be solved without reliance on matrix algebra as proposed by several authors, including Williams and Griffin (1964), Churchill (1964), Livingstone (1968), Jacobs and Marshall (1987), Brown and Killough (1988), and Jennings and Day (1997).  The proposed approach does not result in a circular error, which one encounters when using the techniques recommended by Savage and Wilburn (1997) and Burch (1994). Although a circular error may not necessarily produce incorrect results, spreadsheet software developers, such as Lotus, MicroSoft, and Corel caution that the risks of incorrect results are high and that they do not guarantee the accuracy of the calculations when a circular error exists in a template.