Question 8.3: A motor pool allocates costs to other departments of the sam...
A motor pool allocates costs to other departments of the same organization based on the number of kilometers driven in company vehicles. The motor pool expects to incur annual fixed costs of $200,000 and variable costs of $0.20 per kilometer driven. The motor pool expects company vehicles to be driven for a total of 800,000 kilometers. What is the application rate used by the motor pool? How does that application rate lead to under-use of the motor pool and costly behavior by other departments?
The application rate is total expected costs in the motor pool divided by the total expected kilometers driven:
$200,000+($0.20/kilometers × 800,000 kilometers)/800,000 kilometers =$0.45/kilometer
This application rate, however, is higher than the incremental cost of operating an automobile, which is $0.20 per kilometer. The application rate acts like a transfer price. Therefore, managers in other departments will choose to use other means of transportation, if the cost per kilometer of alternative transportation is less than the application rate of $0.45 per kilometer for the motor pool. The entire organization would benefit, however, if the motor pool were used whenever the cost of the alternative means of transportation exceeded $0.20 per kilometer