VOL. 13, NO.

1 WATER RESOURCES RESEARCH FEBRUARY 1977

The Efficiencyand Equity of Cost Allocation Methods

for Multipurpose Water Projects
JAMES C. LOUGHLIN

Departmentof Economics,Central ConnecticutState College

New Britain, Connecticut 06050

The efficiencyand equity of the separablecosts-remainingbenefits(SCRB), alternative justifiable

expenditure,and useof facilitiesmethodsof costallocation are examined.On efficiencygrounds,only the
SCRB formula satisfiedall three efficiencycriteria. From an equity viewpoint, no one method allocates
costsso that eachpurposesharesfairly in the savingsfrom multiple-purposedevelopment.The sourceof
inequity with the SCRB and alternative justifiable expenditure methods arisesbecauseeither separable
costsor specificcostsare subtractedfrom justifiable costson a 1: I basis.Conceptualproblemsin defining
capacity precludethe use of facilitiesmethod from satisfyingthe equity objective.An adjustmentin the
SCRB methodis proposedwhichwill enablethis procedureto satisfyboth efficiencyand equity criteria.

INTRODUCTION
Recent investigationsof the proceduresfor analyzing fed-
eral water resourceprograms have focusedon the evaluation
and cost-sharingaspectsof project formulation. The recom-
mendations stemming from these studies have stressedthe
need for multiple objectives [U.S. l,Vater ResourcesCouncil,
1973], a change in the discount rate [U.S. I4/ater Resources
Council, 1968], and increasedcost sharing for nonfederal en-
tities [National I4/ater Commission, 1973]. Although the
method of cost allocation affects cost-sharingarrangements,
no comparable researcheffort has been directed at the effi-
ciency and equity of the various methodsfor allocating costs
among project purposes.Congress,in the Water Resources
Development Act of 1974 [U.S. Congress,1974, sect. 80(c)],
directed the Presidentto investigatethe principles and stand-
ards for the planning, evaluation, and cost sharing of water
resourceprojects; however, the 'plan of study' [U.S. Water
ResourcesCouncil, 1975] recently approvedby the U.S. Water
ResourcesCouncil doesnot includea specificexamination of
cost allocation methods. The purposesof this paper are to
analyze the efficiencyand equity of various cost allocation
methods and to suggestchangesin some of the methods to
meet these objectives.
PROJECTEVALUATION,COST AI.I.OCATION,
AND COST SHARING
in discussingthe needto allocatecostsa distinctionmust be
made between project evaluation, cost allocation, and cost
sharing. Project evaluation dealswith the estimationof bene-
fits and costsin order to determine project justification. Cost
allocation is concernedwith the distribution of total project
costsamong the various purposesservedby the project. Once
costs are allocated, cost-sharingor reimbursementpolicy dic-
tates what portion of purpose costswill be shared by federal
and nonfederalentities.Although costallocationcan affectthe
degree of cost sharing, project evaluation and cost allocation
are consideredto be independentof each other. The economic
evaluation of a project in no way dependsupon cost alloca-
tion, becausethe costsallocated to a project purposeare not
the coststo considerin decidingoverall project feasibility,the
optimal scale of development, or whether the purposeshould
be included in the project. A project is economicallyjustified
and properly formulated [Federal Inter-Agency Rit;er Basin
Copyright@ 1977 by the American GeophysicalUnion.
Committee, 1950, p. 37] when (1) the total of all benefits
exceedsthe total of all costs,(2) the scale of developmentis
such as to provide maximum total benefits over total costs,
and (3) the benefits of adding each purpose as the last in-
crement at least equal the separablecostsof the added capac-
ity.
For project feasibility the overall benefit-costratio must be
greater than unity. This involves the comparison of totals
(benefitsand costs),which precludesthe,necessityto allocate
joint costsamong purposes.In decidingthe optimal designof
a project, marginal or incremental analysis is employed to
determine'that scale of development where marginal social
benefitsare equalto marginalsocialcosts.As longasmarginal
benefits exceed marginal costs, an increase in the scale of
development will increase net benefits. Since marginal costs
are independentof joint costs,a cost allocation is not neces-
sary to determineoptimal scale.Similarly, in decidingwhether
to include a function in the project an incrementalanalysisis
employed. As long as the additional benefits from including
the function are equal to or greater than the additional or
separable costs of including the function, inclusion of the
purpose is justified. The benefits of each purpose need only
cover separablecosts,sincejoint costsare sunk and need not
be recouped.This eliminatesthe necessityfor purposebenefits
to cover a part of joint costsand therefore the needto allocate
joint costsamong functionsin decidingpurposejustification.
Do COSTS NEED TO BE ALLOCATED 9.
There is no need to allocate project costsamong purposes
when (1) projects are single purpose, (2) multiple-purpose
projects are nonreimbursable,or (3) reimbursable multiple-
purpose projectsare priced according to economicefficiency
principles in a situation where long-run average cost is not
falling. Prior to the 1930'stherewas little needto allocatejoint
costs,becausevery few federal projectswere multiple purpose
in design. With the advent of the Flood Control Act of 1936
[U.S. Congress,1936], however, the planning of projectsfa-
vored multiple-purposedevelopmentbecauseof the cost sav-
ings from combining several purposesinto a singleproject.
The local reimbursement features of the Flood Control Act of
1936 and subsequentlegislationnecessitateda costallocation
among purposes, so a subcommittee of the Federal Inter-
Agency River BasinCommittee was formed to study ways in
which costs should be allocated. The findings of the cost
allocation committee formed the basis on which the Sub-

Paper number 6W0687.

 LOUGHLIN: COST ALLOCATION METHODS 9

committee on Benefitsand Costs [Federal Inter-Agency River adopted a modificationand extensionof the SCRB method for
Basin Committee, 1950] recommended the separable use in multiobjective and multipurposefederal and federally
costs-remainingbenefits(SCRB) method oF cost allocation. assisted reservoir projects [U.S. Water Resources Council,
The Federalagenciesin the past havegiven minimal consid- 1973]. Thus at presentall water resourceagenciesare applying
eration to assessingbeneficiariesFor project serviceson the the SCRB method in these types of programs. For multiple-
basis of rates establishedthrough competition. Ciriacy-Wan- purpose channel improvements, however, the SCS still em-
trup [1954] was an early exponent oF determining chargesfor ploys the useof facilitiesmethod [U.S. Departmentof Agricul-
project serviceson the basisoFsupplyand demand Functions. ture, 1974].
In recent years [Krutilla, 1966; Flannery, 1968; Hanke and
COST ALLOCATION METHODS
Davis, 1973] there has been a continuation oF interest in the
application oF marginal cost pricing techniquesto the pricing The SCRB method oF cost allocation assignsto each Func-
oF water resourceoutputs. Not only would such a pricing tion the separablecostsoF including the Functionin the mul-
schemelead to short- and long-run efficiency,but in the ab- tiple-purposedevelopmentplus a shareoFthe.joint or common
sence oF decreasingcosts and Full reimbursementoF project costsoFthe project. Joint costsare allocated on the basisoFthe
costs it would obviate the need to allocatejoint costs. Under remaining benefitsaccruingto each Function.A descriptionoF
such a pricing scheme, optimal use oF existing capacity For this allocation procedureis presentedin Table 1.
eachpurposewould be obtainedby settingprice at that output Table I assumesthat total project costs(row 7) amount to
levelwhere demand and short-run marginal costwere equal. IF $350,000 on an average annual basis and includesinvestment
at that output level the price, or marginal benefit to society, cost and operation, maintenance,and replacementcosts.Ben-
were greater than (less than) the long-run marginal costsoF efits, alternative costs,justifiable costs, separable costs, and
added capacity, an expansion(contraction) oFwater resource joint costs are also expressedon an average annual basis.
capacity would be warranted. This process oF adjustment Justifiable costs(row 3) are either the benefits or the alterna-
shouldcontinueuntil price is equal to long-runmarginalcosts. tive costsoFsingle-purposeprojectsproviding the samebene-
At the expanded or contracted level oF project size, price fits, whicheveris the lesser.Justifiablecostscan be interpreted
would alsobe equal to short-runmarginal costs.The optimal as the maximum coststhat an investorwould be willing to pay
scaleof developmentas well as the most efficient use of that to obtain a certain amount oF benefits.
optimal scalewould thus be achieved[Hirshleiferet al., 1960, Separable costs(row 4) are the differencebetween the cost
p. 97]. In the presenceof long-run decreasingaveragecostand oFthe multiple-purposeproject with the purposeincludedand
full reimbursementof project costs, however, application of the costwithout, and they are subtractedFromjustifiable costs
marginal cost pricing would return less than project costs. to arrive at remaining benefits. The subtraction oF separable
Some costswould have to be allocatedto purposesfor collec- costs Fromjustifiable costs is on a 1:1 basis, in contrast to a
tion of lump-sum paymentsfrom beneficiaries. method that weighs allocated separablecostsdifferently and,
Potential for the use of marginal cost pricing exists for the in effect, is a subtraction From justifiable costs on either a
pricing of municipal water services,industrial and municipal greater than or a lessthan 1:1 basis. Separable costsinclude
sewerage,navigation, and flood control [Hanke and Davis, ' not only the specificcostsof including the purpose, such as
1973]. Legislative restrictionson the application of user fees power turbines,transmissionlines, irrigation ditches,and nav-
and past agencypracticeslimit the use of competitivepricing igation locks,but also the addedcostsof a changein the sizeor
in the casesof recreation, fish and wildlife, irrigation, and design of the structure from inclusion of the purpose. For
hydroelectricpower. Until theseobstaclesare removed,it will example, the separablecost of flood control would include the
be necessaryto allocate project costsamong purposesto meet sluicewaysplus the costof increasingthe height of the dam to
statutory and administrative reimbursementrequirements. provide for adequate flood control storage.
Joint costs(row 6) are the differencebetween total project
COST ALLOCATIONAGREEMENTOF MARCH 12, 1954
costsand total separablecostsand are distributedamongeach
On March 12, 1954, an agreementwassignedby the Depart- function in the same proportion as that of the remaining
ment of the Interior, the Department of the Army, and the benefitsof eachfunctionto the total remainingbenefits.Total
Federal Power Commission (unpublished report titled 'Cost allocated costs for each purpose (row 7) are arrived at by
Allocation,' memo. 57981-2, Washington, D.C., March 1954) adding separablecostsand allocatedjoint costs.The benefit-
statingthat the SCRB method of costallocationwas the most cost ratio for the entire project is 1.4 (row I divided by row 7),
acceptablemethod of apportioningcostsamong multiple-pur- indicating an economicallyfeasibleproject.
pose developments.Under certain circumstancesthe agree- The savingsallocated to each purpose (row 8) from com-
ment provided that the alternativejustifiable expenditureand bining the purposesin a multiple-purposedevelopmentare the
use of facilities methods could be employed. Although the differencebetweenthe justifiable costsfor each purpose and
Federal Power Commission,the U.S. Army Corps of Engi- the total costsfor each purpose.Total allocated savingsfrom
neers, and the Bureau of Reclamation have relied on the multiple-purposedevelopmentamount to $50,000. These sav-
SCRB method almost exclusively,the TennesseeValley Au- ingsarisebecausethe average.costof larger reservoirsis lower
thority (TVA) and the Soil ConservationService(SCS) have than that for smaller reservoirsand becausethe same storage
favored the alternativejustifiable expenditureand the use of spacein multiple-purposereservoirsmay be used for two or
facilitiesmethods, respectively.TVA's cost allocation prefer- more functions.The first savingsarisesfrom a more efficient
ence stemsfrom a study conductedin 1938by the TVA Com- use of a given site, while the secondresultsfrom more efficient
mittee on Financial Policy [U.S. Congress,1938], while the use of existingfacilities.
SCS partiality for the use of facilitiesmethod is basedon its The alternative justifiableexpenditure methodof costallo-
ease of calculation and greater comprehensibility by non- cation is sometimesreferredto as the 'specificcosts-remaining
technical people [U.S. Department of Agriculture, 1964]. On benefits'method,sinceit substitutesthe specificcostsof the
September 10, 1973, the U.S. Water ResourcesCouncil various functionsfor their separablecosts.Specificcostsare
10 LOUGHLIN:COSTALLOCATIONMETHODS

TABLE 1. SCRB Method of Cost Allocation

Purpose

Item Description A B C D Total

I Benefits 140 100 150 100 490

2 Alternative costs 100 120 100 130 450
3 Justifiablecosts(lesserof I or 2) 100 100 100 100 400
4 Separablecosts 80 50 20 0 150
5 Remainingbenefits(3 - 4) 20 50 80 100 250
6 Allocatedjoint costs* 16 40 64 80 200
7 Total allocatedcosts(4 + 6) 96 90 84 80 350
8 Allocated savings(3 - 7) 4 10 16 20 50
9 Percentallocatedsavings 8 20 32 40 100
10 Cost.of projectcombiningall otherpurposes 270 300 330 350 .-.
(project cost - 4)
11 Justifiablecostscombining all other purposes•' 270 300 300 300 ...
12 Savingsfrom purposeinclusion(3 + 11 - projectcost) 20 50 50 50 170
13 Percentsavingsfrom purposeinclusion 12 29 29 29 99:[:

Values are in thousandsof dollars except where it is otherwise indicated.

*Total joint costsof $200(projectcostof $350minustotal separablecostof $150) are allocatedto each
purpose in the same ratio as that of the remaining benefitsof each purposeto the total remaining
benefits. For purposeA this becomes($20/$250) X $200 = $16.
'}-Thejustifiablecostscombiningall other purposesare either the costof a projectcombiningall other
purposes(row 10) or the sum of thejustifiablesingle-purposecostsfor all other purposes(row 3), which-
ever is the lesser.
$Totals do not equal 100%owing to rounding.

the costs directly attributed to the purposeand exclude the
costs of a change in project design due to inclusion of the
purpose.Joint costsare arrived at by subtractingall specific
costsfrom total project costs,and they are distributedamong
the various purposes in proportion to remaining benefits.
However, with this formula, remainingbenefitsare calculated
by subtracting specificcosts from justifiable costs on a 1:1
basis. Total allocated costsare the sum of specificcostsand
allocated joint costs. An example of this procedure is illus-
trated in Table 2.
The alternative justifiable expenditure method is recom-
mended in those instances where the data are not available
estimatingseparablecost or when the cost of obtaining such
data would be prohibitive (unpublishedreport titled 'Cost
Allocation,' memo. 57981-2, Washington,D.C., March 1954,
p. 1). A seriesof cost estimatesshowingthe multiple-purpose
project with and without each purposecan be quite expensive.
Since it relies on specificcostsrather than separablecosts,the
alternative justifiable expenditure method is much easier to
calculate than the SCRB method.
The use of facilities method of cost allocation attempts to
allocate joint costs in proportion to the relative use of the
common facilities by each purpose. It thus distributesjoint
costsin proportion to physicalcriteria rather than benefitsas
in the two previousmethods.Such measuresas reservoirstor-
Allocated total costsequal the sumof allocatedjoint costsplus
separableor specificcosts.Table 3 presentsan exampleof the
use of facilities method.
The useof facilitiesmethodis consideredacceptablein those
instanceswhere joint use is clearly determinableon a com-
parative basis. However, becauseof the problem of finding a
common denominator for all purposes,it is usually recom-
mendedonly for suballocatingcostsof a given function in a
single-or multiple-purposedevelopment[Dominy, 1966,p. 9].
THE EFFICIENCY AND EQUITY OF
COST AI.I.OCATION METHODS
for
Any cost allocation method employed should satisfy the
objectivesof economic efficiencyand equity. The conditions
for efficiencyin cost allocation can be stated as follows [U.S.
Department of Agriculture,1964,chap.10,p. 5; U.S. Departmentof
the Interior, 1959,p. 116.5.12]:(1) the separablecostof adding
each purpose as the last increment should not exceed the
benefitsderived therefrom, (2) the sum of the total costsallo-
cated to each purposeshouldnot exceedthe sumof the total
benefits allocated to each purpose, and (3) the total costs
TABLE 2. Alternative Justifiable Expenditure Method of Cost
Allocation

age space, water flow, and energy consumption have been

suggestedto estimatejoint use.Joint costsare determined by Purpose
either subtractingall separablecostsor subtractingall specific Item Description A B C Total
costsfrom total project costs.The SCS favors subtractionof
specificcosts[U.S. Departmentof Agriculture, 1964],while the I BenefitS, 50 70 30 150
2 Alternative costs 35 55 45 135
Federal Power Commission,the Department of the Interior,
3 Justifiablecosts(lesserof I or2) 35 55 30 120
and the Department of the Army prefer to subtractseparable 4 Specificcosts 10 5 5 20
costs to arrive at joint costs(unpublishedreport titled 'Cost 5 Remaining benefits(3 - 4) 25 50 25 100
Allocation,' memo. 57981-2, Washington,D.C., March 1954). 6 Allocatedjoint costs* 15 30 15 60
Joint costs are then distributed among project purposesin 7 Total allocated costs(4 + 6) 25 35 20 80
proportion to a measureof physicalcapacity. For example,if Values are in thousands of dollars.
ßreservoirstorage.spaceof 5000, 3000, aad 2000 ac ft is.needed *TOtaljoint costs•of $60 (projectcostof $80 minustotal specific
for purposesA, B, and C, respectively,purposesA, B, and C costof $20) are allocatedto each purposein the sameratio as that of
are allocated 50%, 30%, and 20%, of joint costs,respectively. the remainingbenefitsof eachpurposeto the total remainingbenefits.
 LOUGHLIN: COST ALLOCATION METHODS 11

TABLE 3. Use of Facilities Method of Cost Allocation Institute,1958,p. 79]. Oncecostsare allocated,equityin cost
sharingis thenconcerned with the distributionof benefitsand
Purpose local costsamong users.The 'fairness'conceptof equity in
Item Description A B C Total cost allocationhasbeenemphasizedby the Subcommitteeon
Benefitsand Costs: 'The objectiveof cost allocation is to
I Benefits 300 250 150 700 distributeprojectcostsequitablyamongthe purposesserved
2 Specificcosts 60 40 20 120 ß.. by providingfor proportionalsharingof thesavings result-
3 Total storage,ac ft 5,000 3,000 2,000 10,000
4 Allocatedjoint costs* 200 120 80 400
ing from multiple-purpose development' [FederalInter-Agency
5 Total ailocatedcosts(2 + 4) 260 160 100 520 RiverBasinCommittee,1950,p. 53]. A similarnotionof equity
in costallocationis providedin the U.S. Bureauof theBudget
Values are in thousandsof dollars exceptwhere it is otherwisein- [1952, p. !1] CircularA-47 and SenateDocument97 [U.S.
dicated.
Congress, 1962,p. 12].Thiscriterion,however,is not satisfied
*Total joint costsof $400 (projectcostof $520 minustotal specific
costof $120) are allocatedto eachpurposein the sameratio as that of by any of the threecostallocationmethods,becauseat least
the storageassignedto eachpurposeto the total storage. two proceduralproblemsexistwhichdo not providefor pro-
portional sharingof project savingsamong purposes.One
sourceof inequitycommonto the SCRB and the alternative
allocatedto each purposeshouldnot exceedthe costof a justifiableexpenditure methodsarisesbecause eitherseparable
single-purpose alternative providing equivalent benefits.All or specificcostsare subtracted from justifiablecostson a 1:1
threeefficiency criteriaare satisfiedby the SCRB method. basis.The questionof the proprietyof thisprocedurehasbeen
However,the alternativejustifiableexpendituremethodand raised elsewhere[Thrall, 1963]. A further equity problem
the use of facilitiesmethod employing specificcostsdo not arisesin attemptingto definecapacitywhenoneis applyingthe
necessarily satisfycondition(1) in thoseinstances wheresepa- use of facilities method.
rablecostsare greaterthan specificcosts.In thesecasesit is To illustratethe first proceduralproblem in apportioning
possiblethat thebenefits
of includinga purposemaybeequal costs, reference is made to Table 1. To obtain remaining
to specificcostsbut lessthan separablecosts.The purpose benefitsfor joint costallocationpurposes,separablecostswere
wouldbejustifiedon the basisof specificcostsbut infeasible subtractedfrom justifiablecostson a 1:1 basis.Inasmuchas
on the basisof separablecosts.Sincethesemethodscannot separable costsare deductedon a 1: I basis(on the assumption
assurethat the separablecostsof addinga purposewill not that thejustifiablecostsfor eachpurposeare equal),the proj-
exceed the benefitsderived from its inclusion in the project, ect savingsallocatedto eachpurposeare not proportionalto
they fail one of the efficiencytests. the savingsfrom inclusionof eachpurposein the project.This
Moreover, the useof facilitiesformula doesnot employthe situation resultsbecausethe separablecostsof adding a pur-
conceptof justifiablecosts,whichplacesan upperlimiton the poseproducepart or all of the savingsfrom multiple-purpose
costsapportionedto a particularpurpose.Inasmuchas this development, yet the separablecostsdo not sharein the sav-
methodallocates joint costson the basisof physicalcriteria,it ingsallocatedto eachfunction.By not creditingtheseparable
ispossiblefor a purpose to beassigneda shareof multipurpose costswith a part of project savingsvia the subtractionof
costsin excessof the costof obtainingthe samebenefitfrom a separablecostsfrom justifiablecostson a greaterthan 1:1
single-purpose alternative[Dominy,1966,p. 7]. For example, basis, all project savingsaccrueentirely to the joint costs.
in Table 3 the total allocated costsfor purposeA amount to Equityin costallocationdictatesthat the savingsallocatedto
$260,000, althoughthe cost of a single-purpose alternative eachfunctionbe proportionalto thesavingsfrom inclusionof
mightbe $250,000.Thereis thereforeno guaranteethat crite- each function in the project.
rion (3) will be met by the useof facilitiesmethod.Sincethe The projectsavingsallocatedto purposes A, B, C, and D in
alternativejustifiableexpenditure and useof facilitiesmethods Table I amounted to $4,000, $10,000, $16,000, and $20,000,
of costallocationdo not necessarily satisfyall threeefficiency respectively.
The savingsfrom includinga purpose,asthe last
criteria, the SCRB methodisjudgedsuperioron the basisof increment,are definedas the savingsin projectcostsattributed
the efficiencyobjective. to inclusionof the purposein excessof the project savings
Equityasan objectiveof projectevaluation,costallocation, obtained from constructinga project consistingof all other
and costsharinghas two meaningsin economics:redistribu- purposes. Rows3, 10, 11,and 12 indicatethe computationof
tion and fairness[MarshallandBroussalian,1971,p. 201]. The the savingsfrom inclusionof a purposein a multiple-purpose
first interpretationhasbeenappliedto projectevaluationand development.For example,the savingsfrom addingpurpose
cost sharing,the secondto cost allocation. In project eval- A (row 12) can be found by adding the justifiablecostsof a
uation,equityrefersto the redistributionof netbenefitsamong projectmadeup of functionsB, C, and D (row 11) and the
beneficiariesof a program. A favorableredistributionoccurs justifiablecostsof purposeA (row 3) and subtractingtotal
when beneficiariesin low per capita incomeareasreceivebene- projectcosts(row 7). The needto estimatethejustifiablecosts
fits from a programthat are proportionallygreaterthan the for a projectwith purposeA deletedresultsfrom the fact that
localcostsof the program.Equity in costsharingcan thusbe part of the total projectsavingsmay be obtainedby construct-
achievedby loweringthe local costsharesin theselow-income inga projectcombiningall otherpurposes. The otherpart of
areas in relation to the benefitsreceived[Marshall and Brous- total projectsavingsresultsfrom the inclusionof purposeA.
salian, 1971, p. 216]. Thus functionA produces$20,000of savingsfrom inclusionin
With regardto cost allocation,equity refersto fairnessin the multiple-purpose development,the other $30,000of total
the distributionof total project costsamongall the purposes projectsavingsbeingprovidedby a projectconsisting of func-
servedby a multiple-purposedevelopment.Specifically,an tions B, C, and D. Since the savingsattributed to adding
equitablecostallocationis onewhich permitsall projectpur- purposeA are $20,000,thisindicatesthat the separable costsof
posesto share fairly in the savingsfrom multiple-purpose includingpurposeA producedthe $20,000of projectsavings.
rather than single-purpose construction[StanfordResearch Similarly, purpose D provides$50,000 of savingsfrom in-
12 LOUGHLIN: COST ALLOCATION METHODS
clusionin the project,while a projectconsistingof purposesA,
B, and C producesno project savings.The separablecostsof
includingpurp9se D thereforeproduce $50,000 of project
savings.
The savingsfrom inclusion of a function can also be found
by subtractingthe savingsfrom multiple-purposedevelopment
with and without the purposeincluded.Deletion of a purpose
eliminatesthe justifiableand separablecostsattributedto that
purpose. For example, elimination of function A leaves a
projectmade up of functionsB, C, and D with total justifiable
costsof $300,000,total projectcostsof $270,000,and savings
of $30,000.Followingthis procedurethe savings,in thousands
of dollars, from adding purposesA, B, C, and D can be
estimated as follows:
S^ = S^,c•) - S•c•)•= 50- 30 = 20
SB = S^,c•)- S^c•) = 50- 0 = 50
Sc = SA,C•) -- SA,O = 50- 0 = 50
SD -- SABCD-- SABC '-- 50- 0 = 50
where S is the savings.In the latter three instances,no project
savingsare attributed to projectswith purposesB, C, and D
deleted,since alternative single-purposeprojectsmade up of
the other purposeswould costthe sameor lessthan a multiple-
purposeproject combiningthe other purposes.
The extent of the inequityin the SCRB method is indicated
by rows 9 and 13 in Table 1. Becauseseparablecostsare not
deductedfrom justifiable costson a greaterthan 1:1 basis,the
separablecostsdo not sharein the savingsfrom combiningthe
purposes.(The samerationale appliesto the alternativejustifi-
able expendituremethod, which subtractsspecificcosts.)The
subtractionof separablecostsfrom justifiable costson a 1:1
basisresultsin all project savingsaccruingto the joint costs.
Yet the separable costs of including purpose A produced
$20,000of savings,and the separablecostsof addingpurposes
B, C, and D produced$50,000of savings.By not creditingthe
separablecostswith a part of the savingsfrom combiningthe
purposesthe savingsallocated to each function are not pro-
portional to the savings resulting from each function's in-
clusionin the project. For example,the inclusionof purposeA
causesapproximatelya 12%increasein savings,yet purposeA
sharesin only 8% of allocatedsavings.Similarly, the inclusion
of purposes B, C, and D causesa 29% increasein project
savingsfor each, whereaspurposesB, C, and D receive20%,
32%, and 40% of allocatedsavings,respectively.Thus purposes
A and B receive a lessthan proportional share of allocated
savings,while purposesC and D receivea greaterthan propor-
tional share.Equity in costallocationrequiresthat the savings
allocatedto each function be proportionalto the savingsaris-
ing from each function's inclusion in the project. A simple
adjustment, however, in the cost allocation processwhich
creditsthe separablecostswith a part of projectsavingswould
overcome this criticism.
Another equity problem, associatedwith the useof facilities
method, involvesmeasuringthe extent to which each project
purposeutilizesthejoint facilities.This methodemploysphys-
ical criteria suchas reservoirstoragespaceor the quantity of
water releasedto determinethe allocation of joint costs.How-
ever, if thesejoint cost allocationsare of an arbitrary nature
owing to ambiguitiesin defining'use,' the allocatedsavingsto
each purposewill bear no meaningfulrelationshipto the sav-
ingsfrom purposeinclusion.A changein the definitionof use
would alter the allocation of joint costsand thus affect the
relationshipbetweenallocatedsavingsand savingsfrom add-
ing the purposeto the project.
Conceptual problems do arise in defining use when one is
employing the use of facilities method [Ransmeier, 1942, p.
359; Gertel, 1951, p. 132; U.S. Congress,1952, p. 6; Eckstein,
1958, p. 263]. Storagespacemay be a good indicator for flood
control usage, but the quantity of water released is a better
measure of irrigation usage. Some purposes,such as hydro-
electric power and navigation, dependupon both conceptsof
use--both the quantity of water releasedand the headthrough
which that volume falls. Head is the vertical difference between
the water levels above and below the dam and therefore de-
pendson reservoircontent. A third definition of useis possible
for reservoir recreational development, which dependsupon
surfacewater and water level fluctuationand not upon reser-
voir storage space or water flow.
Another practical difficulty of the useof facilities method is
that data as to reservoir operation can be accumulatedonly
over long periods of time. Reservoir storage originally set
asidefor flood control may be convertedto water supplyusage
in the future, as needschange.This would alter the original
allocation of joint costsand thereforechangethe relationship
betweenallocatedsavingsand savingsfrom purposeinclusion.
Other problems include the advisability of prorating joint
costson the basisof relativecapacitywhen averagecostsvary
for reservoirsof different size or when a project purposeis
incidental [Ransmeier,1942,p. 359]. The inappropriatenessof
allocatingjoint costson the basisof physicalcriteria has been
noted by Gertel [1951, p. 132];he statesthat the assignmentof
joint costson the basis of reservoircapacity would be analo-
gous to a department store pricing its products in proportion
to the floor space taken up by the various counters. Thus
ambiguitiesin defininga common denominatorfor all project
purposes and other conceptual problems make the use of
facilitiesmethodof cost allocationan arbitrary one. It there-
fore fails the equity test.
Of the three cost allocation methods analyzed the SCRB
method comes the closest to satisfying both the economic
efficiencyand the equity objectives.The SCRB method satis-
fiesall three efficiencycriteria, while the alternativejustifiable
expenditureand the useof facilitiesmethodsdo not satisfyall
three goals in some instances.These casesmay arise when
separablecosts are greater than specificcostsor when allo-
cated costs are not limited by justifiable costs. On equity
grounds the arbitrary nature of the use of facilities method
makes it unacceptable.Although the SCRB and alternative
justifiableexpendituremethodsare also unacceptablefrom an
equity viewpoint, a slightadjustmentin theseformulaewould
satisfythe equity criterion. With the adjustmentin the SCRB
methodthis procedurewould satisfyboth economicefficiency
and equity criteria and thusemergeas the preferredmethodof
cost allocation.
ADJUSTMENT IN THE SCRB METHOD
OF COST ALI.OCATION
One method of adjusting for the inequity in the SCRB
formula would be to apply a credit to the separablecostsso
that separablecostsare subtractedfrom justifiable costson a
greater than 1' I basis.The credit could be in the same ratio as
that of the justifiablecostsfor a purposeplusjustifiablecosts
for all otherpurposesto the total projectcosts.This procedure
would provide better resultsthan the existingSCRB method
for meetingthe equity criterion.
The rationale for this method is that it adjusts separable
 LOUGHLIN: COST ALLOCATION METHODS 13

'IABLE 4. Adjusted SCRB Method of Cost Allocation

Purpose

Item Description A B C D Total

I Benefits 140 100 150 100 490

2 Alternative costs 100 120 lb0 130 450
3 Justifiablecosts(lesserof I or 2) 100 100 100 100 400
4 Separablecosts 80 50 20 0 150
5 Credit* 1.057 1.143 1.143 1.143 ...
6 Adjustedseparablecosts(4X 5) 84.56 57.15 22.86 0 164.57
7 Adjustedremainingbenefits(3 - 6) 15.44 42.85 77.14 100 235.43
8 Allocatedjoint costst 13.12 36.40 65.53 84.95 200
9 Total allocatedcosts(4 + 8) 93.12 86.40 85.53 84.95 350
10 Adjustedallocatedsavings(3 - 9) 6.88 13.60 14.47 15.05 50
II Percentadjustedallocatedsavings 14 27 29 30 100
12 Savingsfrom purposeinclusion• 20 50 50 50 170
13 Percentsavingsfrom purposeinclusion 12 29 29 29 99õ

Valuesare in thousandsof dollars exceptwhere it is otherwiseindicated.

*The credit is found by adding rows 3 and !1 in Table I and dividingby projectcostof $350.
tTotal joint costsof $200(projectcostof $350minustotal separablecostof $150) are allocatedto each
purposein the sameratio asthat of the adjustedremainingbenefitsof eachpurposeto the total adjusted
remaining benefits.
•Table I, row 12.
õTotalsdo not equal 100%owing to rounding.

coststo reflecttheassignment
of a portionof projectsa•,ings
to
the separablecosts.This adjustmentwould decreaseremaining
benefits,joint costs, and total coststo those purposeswith
higher separablecosts.Sinceallocatedsavingswould increase
to those purposeswith higher separablecosts,a more propor-
tionate relationshipbetweenthe savingsallocatedto eachpur-
pose and the savingsfrom purpose inclusion would emerge.
The computation of the credit and its effect on the allocation
of costsis presentedin Table 4. As a resultof this changein the
SCRB method, each purposeis assigneda more proportional
share of the savingsresultingfrom multiple-purposedevelop-
ment. For example, the inclusion of purpose A causedap-
proximately a 12%increasein project savings,while purposeA
now sharesin 14%of allocatedsavings.Similarly, the addition
of purposesB, C, and D causeda 29% increasein project
savings for each, whereas their adjusted share of allocated
savingsamounts to 27%, 29%, and 30%, respectively.A more
equitableallocation of project savingsis achievedby crediting
the separablecostswith a part of project savings.
Although other adjustmentsin the SCRB method, including
the forcing of proportionality, could achievesimilar or better
results, such changesmight not be consistentwith the SCRB
conceptor administrativelyworkable. For example, the forc-
ing of proportionality would necessitatethe forcing of allo-
cated total and joint costs,thereby negating the notion that
joint costsshouldbe apportionedaccordingto remainingben-
efits. It would also be administrativelyawkward for coststo be
allocated in a backward fashion.The superiorityof the pro-
posedmethod is that it enablesthe administratorto adjust for
project
savings
withintheexisting
framework
of theSCRB
method.
SUMMARY AND CONCLUSIONS
The efficiencyand equityof the SCRB, alternativejustifiable
expenditure, and use of facilities methods of cost allocation
have been examined. On efficiencygrounds, only the SCRB
method satisfiedall three efficiencycriteria and thereforewas
judged 'superiorto the others. FrOm an equity viewpoint, all
threemethods
werefoundto beunacceptable.
No onemethod
assignseach project purposea proportional share of the say-
ings arising from multiple-purposedevelopment. The source
of inequity with the SCRB and alternative justifiable ex-
penditure methodsarises becauseeither separableor specific
costsare subtractedfrom justifiable costson a 1:1 basis.With
a simple adjustment in these two methods, equity in cost
allocation can be obtained. The use of facilities method pre-
cludesthe possibilityof a fair sharingof project savingsamong
purposesbecauseof conceptualproblemsin definingreservoir
use. No adjustmentin the useof facilitiesmethod can achieve
equity in cost allocation.
A modificationof the SCRB method is proposedwhich will
enable this method to satisfy both efficiencyand equity cri-
teria.Theproposed
change
in thecostallocation
procedure
would apply a credit to separablecostsin the same ratio as
that of the justifiable costsfor a purpose plus the justifiable
costsfor all other purposesto the total projectcosts.The effect
of this changewould be a tendencyfor the savingsallocatedto
each purposeto bear a more proportionate relationshipto the
savingsfrom inclusionof each purposein the project.
Acknowledgments. The author wishesto expressappreciationto
Harold E. Marshall and to an anonymousreferee for helpful com-
ments on a previous draft.
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