Question

Holbrook Corporation has three​ divisions: pulp,​ paper, and fibers. Holbrook​'s new​ controller, Eric Mayer​, is reviewing the allocation of fixed​ corporate-overhead costs to the three divisions. He is presented with the following information for each division for 2013​: Pulp Paper Fibers Revenues $8,800,000 $16,800,000 $26,900,000 Direct manufacturing costs 3,500,000 8,400,000 10,600,000 Division administrative costs 3,000,000 1,200,000 5,800,000 Division margin $2,300,000 $7,200,000 $10,500,000 Number of employees 390 260 650 Floor space (square feet) 28,600 20,130 61,270 Until​ now, Holbrook Corporation has allocated fixed​ corporate-overhead costs to the divisions on the basis of division margins. Mayer asks for a list of costs that comprise fixed corporate overhead and suggests the following new allocation​ bases: Fixed Corporate Overhead Costs Suggested Allocation Bases Human resource management $1,600,000 Number of employees Facility 3,100,000 Floor space (square feet) Corporate administration 4,800,000 Division administrative costs Total $9,500,000 Allocate 2013 fixed​ corporate-overhead costs to the three divisions using division margin as the allocation base. What is each​ division's operating margin percentage​ (division margin minus allocated fixed​ corporate-overhead costs as a percentage of​ revenues)? 2. Allocate 2013 fixed costs using the allocation bases suggested by Mayer. What is each​ division's operating margin percentage under the new allocation​ scheme? 3. Compare and discuss the results of requirements 1 and 2. If division performance is linked to operating margin​ percentage, which division would be most receptive to the new allocation​ scheme? Which division would be the least​ receptive? Why? 4. Which allocation scheme should Holbrook Corporation​ use? Why? How might Mayer overcome any objections that may arise from the​ divisions?

Answer 1

Answer with working notes and explanation is given below

Pulp $8,800,000 Paper $16,800,000 Fibers $26,900,000 Total $52,500,000 Revenues Less: Direct Manufacturing costs Division administrative costs Division margin $3,500,000 $3,000,000 $2,300,000 $8,400,000 $1,200,000 $7,200,000 $10,600,000 $5,800,000 $10,500,000 $22,500,000 $10,000,000 $20,000,000 Fixed Corporate overhead Human resource management Facility Corporate administration Total Corporate Overheads Total Basis $1,600,000 Number of employees $3,100,000 Floor space (sq feet) $4,800,000 Division administrative costs $9,500,000 1 Allocation using division margin Pulp $8,800,000 $2,300,000 Paper $16,800,000 $7,200,000 Fibers $26,900,000 $10,500,000 A Revenue Division margin Less: Fixed Corporate Overhead allocated 47.5% of Division margin Division Operating margin Division Operating margin % $1,092,500 $3,420,000 $4,987,500 B $1,207,500 13.72% $3,780,000 22.50% $5,512,500 A-B 20.49% L Allocation % based on Division margin Total Corporate overhead Total Division margin $9,500,000 $20,000,000 47.50% Allocation using allocation base suggested by Mayer Pulp Revenue $8,800,000 Division margin $2,300,000 Less: Fixed Corporate Overhead allocated $2,726,000 Division Operating margin $426,000 Division Operating margin % -4.84% Paper $16,800,000 $7,200,000 Fibers $26,900,000 $10,500,000 $1,463,300 $5,736,700 34.15% $5,310,700 As per working below $5,189,300 19.29% Working notes: Number of employees Floor space (sq feet) Division administration cost Pulp 390 28,600 $3,000,000 Paper 260 20,130 $1,200,000 Fibers 650 61,270 $5,800,000 Total 1,300 110,000 $10,000,000 % for allocation Number of employees Floor space (sq feet) Division administration cost Pulp 30.00% 26.00% 30.00% Paper 20.00% 18.30% 12.00% Fibers 50.00% 55.70% 58.00% Total 100.00% 100.00% 100.00% Fixed Corporate Overhead allocation Human resource Facility Corporate administration Total Pulp $480,000 $806,000 $1,440,000 $2,726,000 Paper $320,000 $567,300 $576,000 $1,463,300 Fibers $800,000 $1,726,700 $2,784,000 $5,310,700 Total Allocation $1,600,000 Number of employees $3,100,000 Floor space (sq feet) $4,800,000 Division administrative costs $9,500,000 3 Method 1 allocates Corporate overheads based on Division Margin Method 2 allocates Corporate overheads based on different allocation bases Under method 1 all division are having positive division operating margin since allocation is based on Division margin But under method 2 pulp is reporting net loss since allocation base is different and based on cost drivers used If division performance is linked to operating margin percentage Paper division would be more receptive to new allocation scheme Division Pulp would be least receptive since under new allocation method it is having loss 4 The allocation base suggested by Mayer should be used since those allocation base drives the cost Costs are incurred due to cost drivers and its becomes important to control cost drivers to reduce the cost of the division Division may object the new allocation base but the managers and employees should be trained on importance of controlling the cost through cost drivers Learning's from other division can be shared to realise importance of allocating cost on rational basis