Question

National Bank has several departments that occupy both floors of a two-story building. The departmental accounting system has a single account, Building Occupancy Cost, in its ledger. The types and amounts of occupancy costs recorded in this account for the current period follow.

Depreciation - Building	\(18,000
Interest -Building mortgage	27,000
Taxes – Building and land	9,000
Gas (heating) expenses	3,000
Lighting expenses	3,000
Maintenance expenses	6,000
Total occupancy cost	\)66,000

The building has 4,000 square feet on each floor. In prior periods, the accounting manager merely divided the \(66,000 occupancy cost by 8,000 square feet to find an average cost of \)8.25 per square foot and then charged each department a building occupancy cost equal to this rate times the number of square feet that it occupied. Diane Linder manages a first-floor department that occupies 1,000 square feet, and Juan Chiro manages a second-floor department that occupies 1,800 square feet of floor space. In discussing the departmental reports, the second-floor manager questions whether using the same rate per square foot for all departments makes sense because the first-floor space is more valuable. This manager also references a recent real estate study of average local rental costs for similar space that shows first-floor space worth \(30 per square foot and second-floor space worth \)20 per square foot (excluding costs for heating, lighting, and maintenance).

Required

1. Allocate occupancy costs to the Linder and Chiro departments using the current allocation method.

2. Allocate the depreciation, interest, and taxes occupancy costs to the Linder and Chiro departments in proportion to the relative market values of the floor space. Allocate the heating, lighting, and maintenance costs to the Linder and Chiro departments in proportion to the square feet occupied (ignoring floor space market values).

Analysis Component

3. Which allocation method would you prefer if you were a manager of a second-floor department? Explain.

Short answer

1. Allocated cost:$23,100.
2. Linder:$9,600, Chiro: $12,420.
3. Manager must adopt thenew method of cost allocation.

Step-by-step solution

Step-by-Step SolutionStep 1: Definition of Depreciation

The non-cash expense incurred by the business entity that reduces the value of the fixed assets is known as depreciation. It is charged for complying with the matching principle.

Allocation of occupancy cost

$$\begin{gathered} \mathrm{Allocated}\mathrm{cost}=\mathrm{Total}\mathrm{occupancy}\mathrm{cost}\times \frac{\mathrm{Total}\mathrm{square}\mathrm{feet}\mathrm{used}}{\mathrm{Total}\mathrm{square}\mathrm{feet}} \\ =\mathrm{\$}66,000\times \frac{2,800}{8,000} \\ =\mathrm{\$}23,100 \end{gathered}$$

Allocation of depreciation, interest, and taxes

Total Allocation to Linder:

Particular	Amount $
Value-based allocation $\left(\$54,000\times 60\%\times \frac{1,000}{4,000}\right)$	$8,100
Usage-based allocation $\left(\$12,000\times \frac{1,000}{8,000}\right)$	$1,500
Allocated Cost	$9,600

Total allocation to Chiro:

Particular	Amount $
Value-based allocation $\left(\$54,000\times 40\%\times \frac{1,800}{4,000}\right)$	$9,720
Usage-based allocation $\left(\$12,000\times \frac{1,800}{8,000}\right)$	$2,700
Allocated Cost	$12,420

Working note:

Particular	Value based	Usage Based
Depreciation - Building	$18,000
Interest -Building mortgage	27,000
Taxes – Building and land	9,000
Gas (heating) expenses		3,000
Lighting expenses		3,000
Maintenance expenses		6,000
Total occupancy cost	$54,000	$12,000

Calculation of Total rental value:

Particular	Square feet	X	Per square feet rent	=	Total rent
First floor	4,000	X	$30	=	$120,000
Second floor	4,000	X	$20	=	$80,000
Total value					$200,000

Allocation percentage:

Particular	Floor rent value	/	Total rent value	=	Allocation percentage
First floor	120,000	/	$200,000	=	60%
Second floor	80,000	/	$200,000	=	40%

Preferred allocation method

Particular	Current method	New Method
Second Floor	$14,850	$12,420

The new method of allocating cost will be adopted because lower cost is allocated to the second floor under this method.