Cost Allocation and Opportunity Costs

Bruce L. Miller and A. G. Buckman
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Bruce L. Miller: Graduate School of Management, University of California, Los Angeles, California 90024
A. G. Buckman: School of Business and Economics, California State University, Hayward, California 94542

Management Science, 1987, vol. 33, issue 5, 626-639

Abstract: One explanation for the widespread use of allocated fixed costs is that they can serve as a proxy for difficult-to-calculate opportunity costs. This explanation is pursued by modeling a service department as an M/M/s/s queueing system. Two main results are that the expected value of opportunity costs equals both the incremental productivity of capacity and the optimal transfer price. When the cost of capacity is of the form C(s) = as \alpha and \alpha is close to one, we show that allocated fixed costs are a good proxy for average opportunity costs. However, if there are great economies of scale (\alpha is close to zero), then a method which charges users only for the variable costs of the service department is recommended. Finally, the economic efficiency of transfer prices based on either variable cost or full cost is compared with optimal transfer pricing policies.

Keywords: cost allocation; queueing optimization (search for similar items in EconPapers)
Date: 1987
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:33:y:1987:i:5:p:626-639

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