Question

XLF is a company with three operating divisions located in California, Nevada and Arizona. XLF’s headquarters oversees the three divisions and incurred an annual costs of $2,400,000 in office expenses, accounting costs, and salaries.

	California	Nevada	Arizona
Number of employees	1,500	300	300
Net income (loss) before allocating costs	($100,000)	$400,000	$500,000

1. Allocate the headquarters costs to the three divisions based on number of employees. (3 points)

2. Allocate the headquarters costs to the three divisions based on net income (loss). (3 points)

3. Briefly discuss the advantages and/or disadvantages of the two methods. (4 points)

Answer 1

1. BASED ON NUMBER OF EMPLOYEES :

The ratio of the number of employees is 5:1:1 and the total cost is $2,400,000

Therefore, CALIFORNIA = $2,400,000 * 5 / 7 = $1,714,285.71 = $1,714,286

NEVEDA = $2,400,000 * 1 / 7 = $3,42,857.14  = $342,857

ARIZONA =  $2,400,000 * 1 / 7 = $3,42,857.14  = $342,857

  2.BASED ON NET INCOME :

The ratio of the profits/ losses is 1:4:5 and the total cost is $2,400,000

Therefore, CALIFORNIA = $2,400,000 * 1 / 10 = $240,000

NEVEDA = $2,400,000 * 4 / 10 = $960,000

ARIZONA =  $2,400,000 * 5 / 10 = $1,200,000

3.ADVANTAGES & DISADVANTAGES :

ADVANTAGES

• All the firms are assessed uniformly regardless of profits/losses it makes. Hence, it will automatically motivate the firm to work harder or perform better as there is no opportunity/benefits they can make use of, with respect to loss incurred or lower profits.
• There is a direct relationship between the costs and the variables, branch heads can hence, try to reduce the number of variables so as to reduce the costs. The areas that require immediate attention can easily be spotted and rectifying actions be taken.

DISADVANTAGES

• One of the major disadvantage in this case is that different types of firms are uniformly assessed. That is, no relaxation is given to firms that underperform or those which are actually not able to perform well. This creates an extra burden for the already loss making firms.
• The cost in the above 2 cases are assigned on the basis of their weighted ratios. The main disadvantage of this method is that, there is a direct relationship between the variables and the costs; when the number of variables increase, the costs will also increase. We can say that it is proportional.