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Cost Allocation and Opportunity Costs

Author

Listed:
  • Bruce L. Miller

    (Graduate School of Management, University of California, Los Angeles, California 90024)

  • A. G. Buckman

    (School of Business and Economics, California State University, Hayward, California 94542)

Abstract

One explanation for the widespread use of allocated fixed costs is that they can serve as a proxy for difficult-to-calculate opportunity costs. This explanation is pursued by modeling a service department as an M/M/s/s queueing system. Two main results are that the expected value of opportunity costs equals both the incremental productivity of capacity and the optimal transfer price. When the cost of capacity is of the form C(s) = as \alpha and \alpha is close to one, we show that allocated fixed costs are a good proxy for average opportunity costs. However, if there are great economies of scale (\alpha is close to zero), then a method which charges users only for the variable costs of the service department is recommended. Finally, the economic efficiency of transfer prices based on either variable cost or full cost is compared with optimal transfer pricing policies.

Suggested Citation

  • Bruce L. Miller & A. G. Buckman, 1987. "Cost Allocation and Opportunity Costs," Management Science, INFORMS, vol. 33(5), pages 626-639, May.
    • Handle: RePEc:inm:ormnsc:v:33:y:1987:i:5:p:626-639
    DOI: 10.1287/mnsc.33.5.626
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    Citations

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    Cited by:

    1. Balachandran, Kashi R. & Radhakrishnan, Suresh, 1996. "Cost of congestion, operational efficiency and management accounting," European Journal of Operational Research, Elsevier, vol. 89(2), pages 237-245, March.
    2. Yasin Ceran & Milind Dawande & Dengpan Liu & Vijay Mookerjee, 2014. "Optimal Software Reuse in Incremental Software Development: A Transfer Pricing Approach," Management Science, INFORMS, vol. 60(3), pages 541-559, March.
    3. Sunkyo Kim & Pyeong-Ik Hwang & Jaewan Suh, 2023. "Automatic Generation Control Ancillary Service Cost-Allocation Methods Based on Causer-Pays Principle in Electricity Market," Energies, MDPI, vol. 17(1), pages 1-17, December.
    4. Shiliang Cui & Xuanming Su & Senthil Veeraraghavan, 2019. "A Model of Rational Retrials in Queues," Operations Research, INFORMS, vol. 67(6), pages 1699-1718, November.
    5. Johansen, Soren Glud, 1996. "Transfer pricing of a service department facing random demand," International Journal of Production Economics, Elsevier, vol. 46(1), pages 351-358, December.
    6. Hassin, Refael & Nowik, Irit & Shaki, Yair Y., 2018. "On the price of anarchy in a single-server queue with heterogeneous service valuations induced by travel costs," European Journal of Operational Research, Elsevier, vol. 265(2), pages 580-588.
    7. Radhakrishnan, Suresh & Balachandran, Kashi R., 2004. "Service capacity decision and incentive compatible cost allocation for reporting usage forecasts," European Journal of Operational Research, Elsevier, vol. 157(1), pages 180-195, August.
    8. Tomáš Buus & Jaroslav Brada, 2008. "On the Necessity of Using Average Cost as a Base for Transfer Price," European Financial and Accounting Journal, Prague University of Economics and Business, vol. 2008(3), pages 79-94.
    9. M. Gietzmann & A. Ostaszewski, 1996. "Optimal Disbursement of a Sunk Resource and Decentralised Cost Allocation," Accounting and Business Research, Taylor & Francis Journals, vol. 27(1), pages 17-40.
    10. Vergamini, Daniele & Cuming, David & Davide, Viaggi, 2015. "The Integrated Management of Food Processing Waste: The Use of the Full Cost Method for Planning and Pricing Mediterranean Citrus By-Products," International Food and Agribusiness Management Review, International Food and Agribusiness Management Association, vol. 18(2), pages 1-20, May.
    11. Lambert, Richard A., 2001. "Contracting theory and accounting," Journal of Accounting and Economics, Elsevier, vol. 32(1-3), pages 3-87, December.
    12. Sumita, Ushio & Masuda, Yasushi & Yamakawa, Shigetaka, 2001. "Optimal internal pricing and capacity planning for service facility with finite buffer," European Journal of Operational Research, Elsevier, vol. 128(1), pages 192-205, January.

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    Keywords

    cost allocation; queueing optimization;

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