Question

National Bank has several departments that occupy both floors of a two-story building. The departmental accounting system has a single account, Building Occupancy Cost, in its ledger. The types and amounts of occupancy costs recorded in this account for the current period follow.
Depreciation—Building $31,500
Interest—Building mortgage 47,250
Taxes—Building and land 14,000
Gas (heating) expense 4,375
Lighting expense 5,250
Maintenance expense 9,625
Total occupancy cost $112,000

The building has 7,000 square feet on each floor. In prior periods, the accounting manager merely divided the $112,000 occupancy cost by 14,000 square feet to find an average cost of $8 per square foot and then charged each department a building occupancy cost equal to this rate times the number of square feet that it occupied. Diane Linder manages a first-floor department that occupies 900 square feet, and Juan Chiro manages a second-floor department that occupies 1,800 square feet of floor space. In discussing the departmental reports, the second-floor manager questions whether using the same rate per square foot for all departments makes sense because the first-floor space is more valuable. This manager also references a recent real estate study of average local rental costs for similar space that shows first-floor space worth $40 per square foot and second-floor space worth $10 per square foot (excluding costs for heating, lighting, and maintenance).

Required
a. Allocate all occupancy costs to the Linder and Chiro departments using the current allocation method.
b. Allocate the depreciation, interest, and taxes occupancy costs to the Linder and Chiro departments in proportion to the relative market values of the floor space. Allocate the heating, lighting, and maintenance costs to the Linder and Chiro departments in proportion to the square feet occupied (ignoring floor space market values). Analysis Component
c. Which allocation method would you prefer if you were a manager of a second-floor department? Explain.

Answer 1

Answer:

National Bank

a. Allocation of Occupancy costs to Linder and Chiro Departments, using the current allocation method:

                                     Linder's Department    Chiro's Department

First-floor square feet            900                                1,800

Average occupancy cost        $8                                    $8

Total Occupancy costs         $7,200                           $14,400

b. Allocation of Occupancy costs to Linder and Chiro Departments, using the relative market values of the floor space:

                                               Linder's Department    Chiro's Department

First-floor square feet                            900                      1,800

Relative market value per square foot $40                       $10

Total Occupancy costs:

 Depreciation, interest & taxes       $36,000                 $18,000

 Heating, lighting, & maintenance

 (Rate = $1.375)                                 $1,237.50               $2,475

Total occupancy costs                    $37,237.50            $20,475

c. As a manager of a second-floor department I would prefer the second method, where only the heating, lighting, and maintenance costs are based on the average cost and the rest of the occupancy costs are based on the relative market values of the floor space.  The reason is that it looks more justified given that the two floors do not have the same market value.  Assuming that the two floors command the same market value, then the first method is okay.

Explanation:

a) Data and Calculations:

Depreciation—Building          $31,500

Interest—Building mortgage   47,250

Taxes—Building and land        14,000     $92,750

Gas (heating) expense              4,375

Lighting expense                      5,250

Maintenance expense             9,625      $19,250

Total occupancy cost         $112,000

Total square feet = 14,000

Average occupancy cost based on square feet = $8 ($112,000/14,000)

Building = 7,000 square feet on each floor

Diane Linder's first-floor department = 900 square feet

Juan Chiro's second-floor department = 1,800 square feet

Market rental costs (excluding costs for heating, lighting, and maintenance):

First-floor space = $40 per square foot

Second-floor space = $10 per square foot