On Joint Cost Allocation: Independent Cost Proportional Scheme (ICPS) and Its Properties

Abstract

Allocation of joint costs is an issue that cannot be avoided in situations involving cost-based pricing. The accounting literature is replete with alternative joint cost allocation schemes, including those based on the Shapley value (Shapley [1953], Hamlen et al. [1977; 1980], Roth and Verrecchia [1979]); notions of nucleolus (Schmeidler [1969]), 4,-centers (Spinnetto [1974]), and (Moriarity [1975]). Each of these, except Moriarity's scheme, provides allocations that lie in the core when marginal cost is nonincreasing.' The computational burden2 involved in obtaining nucleolus and 4,-centers has limited much of the discussion in accounting literature to the Shapley value and Moriarity's scheme. The objective of this paper is to develop an alternative scheme for the allocation of joint costs which uses the same equity principle as the Moriarity scheme, that is, sharing of cost savings in proportion to independent costs. When there are three or more cost centers and the marginal costs are nonincreasing, allocations based on Moriarity's scheme may not lie in the core, whereas the Independent Cost Proportional