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P6-6 Allocating Service Department Costs for World Airlines

World Airlines has three service departments: (1) ticketing, (2) baggage handling, and (3) engine maintenance.The service department costs are estimated for separate cost pools formed by department and are allocated to two revenue-producing departments: (1) domestic flights and (2) international flights.World does not differentiate between fixed and variable costs in making allocations. The following data relate to the allocations:

Budgeted Data

Costs Air Miles

Ticketing $5,000,000

Baggage handling $3,000,000

Engine maintenance $7,000,000

Domestic flights 6,000,000

International flights 24,000,000

Required

a. Allocate the service department costs to the revenue-producing departments using air miles as the allocation base.

b. Evaluate the cause-and-effect relationship resulting from the use of air miles as the allocation base. In which of the cost pools do you think the cause-and-effect relationship is the strongest? Suggest alternative allocation bases for the two remaining cost pools with the weakest cause-and-effect relationship.

Solution Summary

Response includes computations and a discussion about cause-and-effect. An alternative allocation method is suggested with reasons.

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