Cost allocation is often the centerpiece of conflict that is resolved in court cases. The litigation usually involves the dispute over how costs are allocated to a product or product line that is of interest to the plaintiff. This is particularly an issue when a company produces some products or services for a price-competitive market while other products or services are produced for a governmental unit on a cost-plus or reimbursement basis.

Nursing Care Inc., or NCI, operates both a small nursing home and retirement home. There is a single kitchen used to provide meals to both the nursing home and retirement home, meaning labor costs and utilities costs of the kitchen are shared by the two homes. There is also a centralized cleaning department that provides the cleaning services for both homes as well as the kitchen. The nursing home serves only indigent patients who are on Medicaid. The state Department of Health and Family Services (DHFS) reimburses NCI at Medicaid-approved cost reimbursement rates. The Medicaid reimbursement rates are based on cost information supplied by NCI. The relevant cost and allocation data for the most recent year appear in the following table:

                                           Annual Operating Cost
Cleaning department.................................$ 90,000
Central kitchen..........................................$120,000

Required

1. Management of NCI currently allocates the kitchen and cleaning department costs based on the number of residents in each home. Determine the amount of service department costs assigned to each of the homes using this allocation base. Round percentages to two decimal places in your calculations.

2. DHFS auditors believe the step method of allocation should be used by first assigning cleaning costs based on square feet and then kitchen costs based on number of residents. Determine the amount of service department costs assigned to each of the homes using this allocation method.

3. Provide some comments as to why NCI might prefer its selected allocation method over the one supported by DHFS. Are there ethical implications related to the decision?

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Nursing Home Retirement Home 3,000 4 Kitchen Allocation Base Square feet of space Number of residents 1,000 2,000