Space Products manufactures commercial and military satellites. Under its defense contracts, the company is permitted to allocate administrative and other costs to its military division. These costs are then reimbursed by the Department of Defense (DOD). Under DOD guidelines, administrative costs can be allocated using either the direct costs incurred in the operating divisions or the number of employees as an allocation base. Management information systems (MIS) costs can be allocated either on the basis of direct costs incurred in the operating divisions or on the basis of CPUs (a measure of computer resources used). Data concerning the company’s operations appear here.

REQUIRED

The MIS department is responsible for computer equipment and systems, and it maintains databases for the entire organization. 

A. Suppose Space Products uses the step-down method for allocating support department costs. Administrative costs are allocated first on the basis of the number of employees, and then MIS costs are allocated on the basis of CPUs. How much support department cost will be allocated to the military division?

B. Space Products produced 100 military satellites in the period considered in this problem. Assuming the company uses the allocations calculated in part (A), what is the average cost per military satellite?

C. Is the average cost that you calculated in part (B) most likely an underestimate, overestimate, or unbiased estimate of the incremental cost of producing one more military satellite? Explain.

D. Suppose Space Products uses the direct method of allocating support department costs. What is the maximum amount of support department cost that can be allocated to the military division under DOD rules?

E. Suppose the management of Space Products always calculates its support department cost allocations to maximize the amount of contribution received from the DOD. Management selects this policy because it allows the company to be more competitive in its commercial markets.

1. Discuss possible reasons why the DOD does not specify a single, unambiguous support cost allocation method.

2. From a taxpayer’s point of view, discuss whether you would agree with Space Product’s policy.

3. From a competitor’s point of view, discuss whether you would agree with Space Product’s policy.

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Support Departments Operating Departments Commercial $200,000 $2,000,000 $4,000,000 40 30 MIS Military Direct costs Employees CPUs (millions) Administrative $600,000 20 20 10 50 50 70