A Cost Allocation Model for Random-Variable Cost Functions

Traditional cost allocation procedures do not explicitly consider the stochastic nature of costs. This paper presents a methodology that can be used to incorporate the probabilistic aspect of cost estimates. Such probabilistic information has the potential to be much more informative for decision-making purposes. The specific objectives of this paper are to: (1) illustrate the simplicity with which stochastic cost estimation procedures can be implemented; (2) demonstrate how computer software packages can be utilized to estimate the underlying parameters even when the data is non-normally distributed; and (3) illustrate how a predetermined measure of “conservatism” can be incorporated into internal decision making. The study includes an illustration which demonstrates how the discussed procedures can easily be implemented by users with only minimal statistical expertise.