Question

Harmon’s has several departments that occupy all floors of a two-story building that includes a basement floor. Harmon rented this building under a long-term lease negotiated when rental rates were low. 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.

Building rent	\(400,000
Lighting expenses	25,000
Cleaning expenses	40,000
Total occupancy cost	\)465,000

The building has 7,500 square feet on each of the upper two floors but only 5,000 square feet in the basement. In prior periods, the accounting manager merely divided the \(465,000 occupancy cost by 20,000 square feet to find an average cost of \)23.25 per square foot and then charged each department a building occupancy cost equal to this rate times the number of square feet that it occupies.

Jordan Style manages a department that occupies 2,000 square feet of basement floor space. In discussing the departmental reports with other managers, she questions whether using the same rate per square foot for all departments makes sense because different floor space has different values. Style checked a recent real estate report of average local rental costs for similar space that shows first-floor space worth \(40 per square foot, second-floor space worth \)20 per square foot, and basement space worth $10 per square foot (excluding costs for lighting and cleaning).

Required

1. Allocate occupancy costs to Style’s department using the current allocation method.

2. Allocate the building rent cost to Style’s department in proportion to the relative market value of the floor space. Allocate to Style’s department the lighting and cleaning costs in proportion to the square feet occupied (ignoring floor space market values). Then, compute the total occupancy cost allocated to Style’s department.

Analysis Component

3. Which allocation method would you prefer if you were a manager of a basement department?

Short answer

1. Allocated cost under current method:$46,500.
2. Allocated cost under relative market value:$22,500.
3. New method of allocating costs will be preferred.

Step-by-step solution

Definition of Rent Expense

The expense incurred or the cost paid by the business unit against the space utilized for business operation is reported as rent expense in the income statement.

Allocation of occupancy cost to departments using the current allocation method

$$\begin{gathered} \mathrm{Allocated}\mathrm{cost}=\mathrm{Total}\mathrm{occupancy}\mathrm{cost}\times \frac{\mathrm{Total}\mathrm{squarefeet}\mathrm{used}}{\mathrm{Total}\mathrm{square}\mathrm{feet}} \\ =\mathrm{\$}465,000\times \frac{2,000}{20,000} \\ =\mathrm{\$}46,500 \end{gathered}$$

Allocation of building rent in proportion to relative market value

Total Allocation to Style Department:

Particular	Amount $
Value-based allocation $\left(\$400,000\times 10\%\times \frac{2,000}{5,000}\right)$	$16,000
Usage-based allocation $\left(\$65,000\times \frac{2,000}{20,000}\right)$	$6,500
Allocated Cost	$22,500

Working note:

Particular	Value-based	Usage-Based
Depreciation - Building	$400,000
Lighting expenses		25,000
Cleaning expenses		40,000
Total occupancy cost	$400,000	$65,000

Calculation of Total rental value:

Particular	Square feet	X	Per square feet rent	=	Total rent
Basement	5,000	X	$10	=	$50,000
First floor	7,500	X	$40	=	$300,000
Second floor	7,500	X	$20	=	$150,000
Total value					$500,000

Allocation percentage:

Particular	Floor rent value	/	Total rent value	=	Allocation percentage
Basement	$50,000	/	$500,000	=	10%
First floor	300,000	/	$500,000	=	60%
Second floor	150,000	/	$500,000	=	30%

Preferred allocation method

Department	Current allocation method	Relative value allocation method
Style’s department	$46,500	$22,500

The business entity must allocate the cost using the new method because this method reflects lower costs than the current allocation method.