Question

EXERCISE 6-2. [LO 2] Mansard Hotels has five luxury hotels located in Boston, New York, Chicago, San Francisco, and Los Angeles. For internal reporting purposes, each hotel has an income statement showing its revenue and direct expenses. Additionally, the company allocates to each hotel a share of general administrative and advertising costs (e.g., salary of the company president, salary of the company CFO, hotel chain advertising, etc.) based on relative revenue.

a. Write a paragraph explaining why the allocation of general administrative and advertising costs to the specific hotels is potentially useful or potentially harmful.

Answer 1

Ans. Allocation of general administrative and advertising costs to the specific hotels is potentially useful. Reason behind this is plain and simple that these expenses are incurred for all hotels, not for any specific hotel. So, they should be allocated to all hotels on some reasonable basis. Like in case of mansard hotels they have been allocated on basis of relative revenue of each hotel. Salary of the company president, salary of the company CFO, hotel chain advertising, etc are incurred for all hotels in general. Besides allocation also gives the correct picture of income statement and financial position of each hotel correctly. If these expenses were incurred to one hotel only then there would be high probability of that hotel showing loss, but in actual that hotel was earning profit. Based on above discussion we can say that allocation of general administrative and advertising costs to the specific hotels is potentially useful.