Question

8:36 Done Exercise Cost Allocation2.docx 14-17 Cost allocation and decision making. Greenbold Manufacturing has four divisions named after its locations: Arizona, Colorado, Delaware, and Florida. Corporate headquarters is in Minnesota. Greenbold corporate headquarters incurs $5,600,000 per period, which is an indirect cost of the divisions. Corporate headquarters currently allocates this cost to the divisions based on the revenues of each division. The CEO has asked each division manager to suggest an allocation base for the indirect headquarters costs from among revenues, segment margin, direct costs, and number ot employees. The tollowing is relevant intor- mation about each division: Arizona Colorado Delawae Florida $7.800.000 鄚00.000 $6,200,000 $5,500,000 300,0004,100,000 4300,000 4600,000 Segment margin $2,500,000 400000 $1,900,000 900,000 nues Direct costs Number of employees 2,000 ,000 1,500 500 1. Allocate the indirect headquarters costs of Greenbold Manufacturing to each of the four divisions using revenues, direct costs, segment margin, and number of employees as the allocation bases. Calculate operating margins for each division after allocating headquarters costs. 2 Which allocation base do you think the manager of the Florida division would prefer? Explain. 3 What factors would you consider in deciding which allocation base Greenbold should use? Suppose the Greenbold CEO decides to use direct costs as the allocation base. Should the Florida divi- sion be closed? Why or why not?

Answer 1

Workings for 1. :
Allocation base	Arizona	Colorado	Delaware	Florida	Total of the allocation base
Revenues	7800000	8500000	6200000	5500000	28000000
Segment Margin	2500000	4400000	1900000	900000	9700000
Direct costs	5300000	4100000	4300000	4600000	18300000
No.of employees	2000	4000	1500	500	8000
Ratios to total under each allocation base( calculated from above table)
Revenues	27.86%	30.36%	22.14%	19.64%	100%
Segment Margin	25.77%	45.36%	19.59%	9.28%	100%
Direct costs	28.96%	22.40%	23.50%	25.14%	100%
No.of employees	25.00%	50.00%	18.75%	6.25%	100%
1..IndirectHQ costs allocated on the basis of revenues
Revenues	7800000	8500000	6200000	5500000
Less: Direct costs	5300000	4100000	4300000	4600000
Less:Allocated HQ costs	1560000	1700000	1240000	1100000
Operating margin	940000	2700000	660000	-200000
Indirect HQ costs allocated on the basis of direct costs
Revenues	7800000	8500000	6200000	5500000
Less: Direct costs	5300000	4100000	4300000	4600000
Less:Allocated HQ costs	1621858	1254645	1315847	1407650
Operating margin	878142	3145355	584153	-507650
Indirect HQ costs allocated on the basis of segment margin
Revenues	7800000	8500000	6200000	5500000
Less: Direct costs	5300000	4100000	4300000	4600000
Less:Allocated HQ costs	1443299	2540206	1096907	519588
Operating margin	1056701	1859794	803093	380412
Indirect HQcosts allocated on the basis of no.of employees
Revenues	7800000	8500000	6200000	5500000
Less: Direct costs	5300000	4100000	4300000	4600000
Less:Allocated HQ costs	1400000	2800000	1050000	350000
Operating margin	1100000	1600000	850000	550000
Summary of Operating Margins under 4 allocation bases
Revenues	940000	2700000	660000	-200000
Direct costs	878142	3145355	584153	-507650
Segment margin	1056701	1859794	803093	380412
No.of emp.	1100000	1600000	850000	550000

2. From the above summary of operating margins under different allocation bases , the Florida manager will prefer

the No.of employees --base

as the incidence of allocated HQ costs are the least under this option --thus resultinh in greter operating margin

3..

Allocation of indirect HQ costs to divisions must be based on the activities that are performed purely for the benefit of / or that can be resonably attributed to the Division concerned--

so that the particular division is not unnecessarily burdened with irrelevant costs ,which will in turn show the profitability /efficiency of the division in poor light.

4. NO, the Florida Division should not be closed--

as before allocation of the HQ costs , the Florida Division produces a POSITIVE sement margin of $ 900000

that contributes to meeting the HQ costs.

If this division is closed,overall profitability will be reduced due to the absence of the above segment contribution.