The carpool of a major city provides cars for the use of various city departments. Currently, the carpool has 50 cars. A recent study showed that it costs £2,400 of annual fixed cost per car plus £.10 per mile variable cost to own, operate and maintain cars like those provided by the carpool.
Each month, the costs of the carpool are allocated to the user departments on the basis of miles driven. On average, each car is driven 24,000 miles annually, although wide month-to month variations occur. In April 20X7, the 50 cars were driven a total of 50,000 miles. The carpool’s total costs for April were £19,000.
The chief planner for the city always seemed concerned about her car costs. She was especially upset in April when she was charged £5,700 for the 15,000 miles driven in the department’s five cars. This is the normal monthly distance in the department. Her memo to the head of the carpool stated, ‘I can certainly get cars at less than the £.38 per mile you charged in April.’ The response was, ‘I am under instructions to allocate the carpool costs to the user departments. Your department was responsible for 30 per cent of the April usage (15,000 miles ÷ 50,000 miles) so I allocated 30 per cent of the carpool’s April costs to you (.30 × £19,000). That just seems fair.’
1. Calculate the city’s average annual cost per mile for owning, maintaining and operating a car.
2. Explain why the allocated cost in April (£.38 per mile) exceeds the average in number 1.
3. Describe any undesirable behavioral effects of the cost-allocation method used.
4. How would you improve the cost-allocation method?