Court and Kneigh is a public accounting entity that offers auditing and tax services to local small entities. The partners are in dispute over who contributes the greater amount to the entity's profit. The area of contention is the allocation of indirect costs. The tax partners argue for allocating indirect costs on the basis of 40 per cent of professional labour dollars, while the audit partners argue for implementing an activity-based approach to indirect cost allocation. The partners agree to use next year's budgeted data for the purposes of analysis and comparison. Budgeted direct costs are $1 500 000 for audit services and $1 000 000 for tax services. The entity's accountant has provided the following indirect cost analysis.
The analysis has revealed that travel costs can now be considered a direct cost to the audit and tax services. Travel requisitions are to be used as the source documentation to trace the costs. The only other direct costs are professional labour costs, and these are shown in the table.
Required:
a. Using the current approach to cost allocation, compute the total indirect cost assigned to each service.
b. Using the activity approach to cost allocation, compute the activity cost rates.
c. Assign the indirect costs to each service, using the activity cost rates calculated in b. above.
d. Calculate the total cost for both audit and tax services under each cost allocation method.
e. Write a report to the partners advising which cost allocation method you would recommend.