Question

The Pitt Corporation has been outsourcing data processing in the belief that such outsourcing would reduce costs and increase corporate profitability. In spite of this, there has been no meaningful increase in corporate profitability.

Previously, Pitt used a single-rate method to allocate data processing costs. A per unit cost for data processing was computed and compared to the price of the outside supplier. The price of the outside supplier was lower and thus, the outside bid was accepted.

Discuss a possible reason why Pitt's profitability has not shown improvement in terms of the cost allocation method used.

Answer 1

Single rate allocation method is based on the concept that single rate shall used from cost pool and allocated. The single-rate cost allocation puts fixed and variable costs together under their own cost pool.

The disadvantage of this cost allocation comparison is that fixed costs are included in the cost and will continue. Thus, Pitt may have been spending more funds in total and it is greater than if the work was performed in-house.