A company has two major businesses that it operates. One business manufactures a

Question

A company has two major businesses that it operates. One business manufactures and sells unicycles for commerial use in circuses and so forth ( total sales of $150M), and the other sells bicycles to the public ( total sales of $20M). The unicycle business occupies 75,000 square feet of the manufacturing warehouse, and the bicycle business occupies the remaining 25,000 square feet. Cost were split 50-50 between the 2 businesses for advertising ( total advertising expense of $5M) and warehouse expense (total warehouse expense of $3M) in the past (traditional method).
1. What was the cost of advertising and warehouse expense allocated to each of the businesses based on the traditional method?

2. What recommendations would you make in allocating these expenses to each of the businesses, and how much would be allocated to each business?

3. What would be some of the issues of too many expenses or too little expenses being allocated to each of the businesses?

Explanation / Answer

in the traditional method the costs were split 50-50 between the two busines: Total advertising cost = $5 M. Cost allocated to Unicycles= $2.5 M cost allocated to bicycles = $2.5 M Total warehousing cost = $3 M. Cost allocated to Unicycles = $1.5 M And cost allocated to Bicycles = $1.5 million My recommendation will be to allocate costs based on the benefit derived by the business. This would promote efficiency and businesses will be interested in controlling costs. For advertising, the benefit derived is sales and so the cost should be allocated based on sales. Total sales are 150+20 = $170 million. Advertising cost allocated to Unicycles = 5 X 150/170 = $4.41 million Advertising cost allocated to Bicycles = 5 X 20/170 = $0.59 million The warehousing cost should be allocated based on the use of space since this cost is related to space. Total space used is 75,000+25,000=100,000 Warehousing cost allocated to Unicycles = 3 X 75,000/100,000 = $2.25 million Warehousing cost allocated to Bicycles = 3 X 25,000/100,000 = 0.75 million 3. The issues relate to efficiency and pricing. When too little expenses are allocated, business is not interested in controlling these expenses and so there is inefficiency in the use of resources. When too many expenses are allocated, pricing becomes too high and that impacts the sales and profits of a business.

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