Author Question: Cost allocation and decision making. Greenbold Manufacturing has four divisions named after its ... (Read 82 times)

Yi-Chen · **on:** Jul 6, 2018

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 8,400,000 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 of employees. The following is relevant information about each division:

Required:
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?
4. Suppose the Greenbold CEO decides to use direct costs as the allocation base. Should the Florida division be closed? Why or why not?

Question 2

Espanola Co purchases equipment with a cost of 25,000 and a trade-in value of 4,000 . Espanola Co estimates that the equipment will have a useful life of 7 years. Assuming Espanola Co has depreciated the equipment for a total of 4 years using the straight-line method, what is the book value of the equipment?
a. 12,000
b. 13,000
c. 8,000
d. None of the answers listed

otokexnaru · **Reply #1 on:** Jul 6, 2018

Answer to Question 1

1. Allocations based on revenues.
Arizona Colorado Delaware Florida Total
1. Revenues 11,700,000 12,750,000 9,300,000 8,250,000 42,000,000
2. revenues
(11,700,000; 12,750,000; 9,300,000; 8,250,000 42,000,000) 27.86 30.36 22.14 19.64 100
3. Allocated headquarter cost
(Row 2 8,400,000) 2,340,240 2,550,240 1,859,760 1,649,760 5,600,000

Arizona Colorado Delaware Florida Total
Segment margin 3,750,000 6,600,000 2,850,000 1,350,000 14,550,000
Less: Headquarter costs 2,340,240 2,550,240 1,859,760 1,649,760 8,400,000
Division margin 1,409,760 4,049,760 990,240 (299,760) 6,150,000

Allocations based on direct costs.
Arizona Colorado Delaware Florida Total
1. Direct Costs 7,950,000 6,150,000 6,450,000 6,900,000 27,450,000
2. direct costs 7,950,000; 6,150,000; 6,450,000; 6,900,000
27,450,000 28.96 22.40 23.50 25.14 100
3. Allocated headquarter cost
(Row 2 8,400,000) 2,432,640 1,881,600 1,974,000 2,111,760 8,400,000

Arizona Colorado Delaware Florida Total
Segment margin 3,750,000 6,600,000 2,850,000 1,350,000 14,550,000
Less: Headquarter costs 2,432,640 1,881,600 1,974,000 2,111,760 8,400,000
Division margin 1,317,360 4,718,400 876,000 (761,760) 6,150,000

Allocations based on segment margin.
Arizona Colorado Delaware Florida Total
1. Segment Margins 3,750,000 6,600,000 2,850,000 1,350,000 14,550,000
2. segment margins 3,750,000; 6,600,000; 2,850,000; 1,350,000
14,550,000 25.77 45.36 19.59 9.28 100
3. Allocated headquarter cost
(Row 2 8,400,000) 2,164,680 3,810,240 1,645,560 779,520 8,400,000

Arizona Colorado Delaware Florida Total
Segment margin 3,750,000 6,600,000 2,850,000 1,350,000 14,550,000
Less: Headquarter costs 2,164,680 3,810,240 1,645,560 779,520 8,400,000
Division margin 1,585,320 2,789,760 1,204,440 570,480 6,150,000

Allocations based on number of employees.
Arizona Colorado Delaware Florida Total
1. Number of Employees 3,000 6,000 2,250 750 12,000
2. Number of employees 3,000; 6,000; 2,250; 750
12,000 25 50 18.75 6.25 100
3. Allocated headquarter cost
(Row 2 8,400,000) 2,100,000 4,200,000 1,575,000 525,000 8,400,000

Arizona Colorado Delaware Florida Total
Segment margin 3,750,000 6,600,000 2,850,000 1,350,000 14,550,000
Less: Headquarter costs 2,100,000 4,200,000 1,575,000 525,000 8,400,000
Division margin 1,650,000 2,400,000 1,275,000 825,000 6,150,000

2. The Florida Division manager will prefer to use the number of employees as the allocation base because it results in the highest operating margin for the division.

3. The Arizona Division and the Delaware Division receive roughly the same percentage allocation of headquarter costs regardless of the allocation base used (Arizona range = 2529; Delaware range = 18.7523.5). However, the Colorado Division and the Florida Division vary widely (Colorado range = 22.450; Florida range = 6.2525.1). All four methods are reasonable options, but none clearly meets the cause-and-effect criterion for selecting the allocation base. If larger divisions tend to consume more of headquarters' resources, then using division revenues or number of employees seem to be the best choices. Without compelling reason to change, Greenbold should stay with the division revenues as the allocation base.
Another alternative is to use segment margin as the allocation base on the grounds that this best captures the ability of different divisions to bear corporate overhead costs.

4. If Greenbold elects to use direct costs as the allocation base, the Florida Division will appear to have a 761,760 operating loss. Even so, the Florida Division generates a 1,350,000 segment margin before allocating the cost of the corporate headquarters. As seen in the analysis in requirement 1, different allocation bases yield different operating incomes for the Florida Division, with the direct cost allocation base being the lowest. The Florida Division should not be closed because (1) the choice of allocation base is not based on a cause-and-effect relation (i.e., it is arbitrary), and (2) the division earns positive segment margin, which contributes to covering the cost of the corporate headquarters. The Florida Division should only be closed if closing it will save more than 761,760 in corporate headquarter costsa highly unlikely scenario.

Answer to Question 2

B