12-A3 Allocation of Central Costs
The Central Railroad allocates all central corporate overhead costs to its divisions. Some costs, such as specified internal auditing and legal costs are identified on the basis of time spent. However, other costs are harder to allocate so the revenue achieved by each division is used as an allocation base. Examples of such costs are executive salaries, travel, secretarial, utilities, rent, depreciation, donations, corporate planning, and general marketing costs.
Allocations on the basis of revenue for 20X7 were (in millions):
Division Revenue Allocated Costs
Northern $120 $ 6
Midwest 240 12
Texas-Oklahoma 240 12
Total $600 $30
In 20X8, Northern’s revenue remained unchanged. However, Texas-Oklahoma’s revenue soared to $280 million because of unusually large imports from Mexico. The latter are troublesome to forecast because of variations in world markets. Midwest had expected a sharp rise in revenue, but severe competitive conditions resulted in a decline to $200 million. The total cost allocated on the basis of revenue was again $30 million, despite rises in other costs. The president was pleased that central costs did not rise for the year.
1. Compute the allocations of costs to each division for 20X8.
2. How would each division manager probably feel about the cost allocation in 20X8 as compared with 20X7? What are the weaknesses of using revenue as a basis for cost allocation?
3. Suppose the budgeted revenues for 2002 were $120 million, $240, and $280, respectively, and the budgeted revenues were used as a cost driver for allocation. Compute the allocations of costs to each division for 20X8. Do you prefer this method to the one used in requirement 1? Why?
4. Many accountants and managers oppose allocating any central costs. Why?
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