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Allocation of Fixed Costs for Commercial Organizations

Introduction

“Cost allocation” is the process of identifying and allocating the costs of a multi-purpose project among the various authorized project purposes” (US Department of the Interior). The costs are allocated every year based on the costs incurred for plant-in-service and the maintenance thereof. “The cost allocation phase updates (1) the respective repayment obligations of the reimbursable project functions (which include irrigation and M&I water supply and power) and (2) the costs allocated to non-reimbursable project functions including flood control, navigation, recreation, fish and wildlife and water quality improvement.” (US Department of the Interior). There are different factors, which can be arrived at by using the Separable Cost-Remaining Benefits (SCRB) cost allocation method. These factors form the basis for allocating plant-in-service costs.

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Process of allocation of costs in Central Valley Project

The process of allocation of costs involves breaking down those costs, which can be identified and assigned them directly to the appropriate cost category. Secondly, out of those costs identified, the costs, which are to be allocated according to a congressional directive, are allocated according to the respective directives. Third, the capital investments, which are meant to meet a single purpose only, are allocated in full to the specific category. Next, costs to the multi-purpose projects follow a different scheme of cost allocation where separable and joint cost allocation factors form the basis for allocation. Initially, it becomes necessary to identify the total costs that need to be allocated among projects as separable costs. For arriving at these total costs, separable cost factors are used. Joint cost allocation factors determine the method by which the balance of the costs is allocated. Therefore, in order to arrive at the total costs, which need to be allocated to a project it is necessary to take into account both the separable costs and that part of the joint costs, which are assigned to that specific purpose. These two costs are to be totaled (ChapterIII).

I am not in favor of this approach to allocate the costs because there is fundamentally a difference between the cost allocation and the repayment schedule. For instance, in the case of water supply, the costs are distributed using factors on the type of facility used. However, this does not match with the repayment schedules as well as with the reimbursement functions of water supply, irrigation supply, and commercial power. Similarly, in the case of power costs, the costs are allocated between project use and commercial use. In case of project use, the costs are allocated in proportion to the costs incurred in the previous year among the three reimbursable functions.

Situations when common costs are allocated

The type of facility used forms the basis for cost allocation in the case of water supplies. This is because the factors used to determine water supply repayment obligations, do not fluctuate considerably over the period.

In the case of projects, which consume power, the costs, which are sub-allocated are further subjected to revised sub-allocation among other functions. These functions are M&I, irrigation and wildlife refuge.

In respect of Fish & Wildlife functions, irrigation, M&I water users and commercial power consumers get the reimbursable mitigation costs assigned to them.

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The recreation payments are allocated to a different set of functions. These functions are recreation and cost-sharing with non-Federal entities.

Joint cost allocation factors form the basis for allocating costs in multi-purpose facilities.

Impact of allocating common costs for internal decision-making

There are two implications associated with the allocation of common costs for internal purposes. Mainly this type of cost allocation helps in identifying the costs, which are reimbursable costs, representing those costs that will be paid for by the customers. It also segregates the non-reimbursable costs, which cannot be recovered from the customers. This implies that these costs are met from the taxpayers’ money. The advantage of this type of cost allocation is that there is the possibility of making the decision-making efficient to predict future expenses with a great degree of accuracy. This facilitates the drafting of more accurate budgeting. In addition, there is an additional advantage with this type of allocation in that it enables the decision-makers to place their requirements before congress with ease and accuracy. Moreover, with this type of allocation of cost, the governmental regulations in the form of legislative measures can be fulfilled without ambiguity.

Impact of not allocating common costs for internal decision-making

There are certain costs, like the federal share of the safety of dam improvements, archeology, cultural and historical, highway improvement, and interest during construction. The impact of not allocating these common costs is that the costs can be identified as non-reimbursable costs. When these costs remain not allocated, it implies that they are not directly identifiable costs. They are not single-purpose costs either and therefore cannot be allocated by way of legislation. This puts a burden on the internal decision-making process to devise an acceptable method by which these costs can be allocated.

Impact of Cost Allocation on the Internal Decision Making

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Unless a proper cost allocation method is not devised, it may not be possible for the decision-makers to decide on segregating the reimbursable and non-reimbursable costs. Without arriving at the proportion of the amount, which needs to be reimbursed by the users of the services, there will be an additional burden on the taxpayers to substitute the non-reimbursable costs. The following table illustrates this position.

CVP Cost Allocation Repayment Responsibilities

Table 1. Cost $ Million

Repayment Entity Sep 1999 Sep 2000
M&I Water users 436.5 452.0
Irrigation Water Users 1,476.2 1,528.0
Commercial Power Customers 568.8 538.0

From the above table, it can be seen that in the case of commercial power consumers the repayment responsibility has gone down in the year 2000 and an improper allocation of costs to the commercial power consumers might be the reason for the reduction in the reimbursable amount.

Conclusion

Handling fixed costs has been a complex problem for business organizations as well as multi-purpose government projects. There is the need for devising a proper method for allocating all common costs and with the enlargement of allocable costs, this process has become more complex. An improper or lack of proper allocation might result in shifting the burden on the taxpayer instead of the respective department or user paying for the common costs.

References

  1. Chapter III. (n.d.). Existing CVP Plant-in-Service Cost Allocation.
  2. US Department of the Interior. (n.d.). Rate Setting Process – Cost Allocation.

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References

StudyCorgi. (2022) 'Allocation of Fixed Costs for Commercial Organizations'. 20 April.

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