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Why should a company be wary of rewarding managers based on numbers that include allocated costs?

Why should a company be wary of rewarding managers based on numbers that include allocated costs?

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Answer #1

Allocated costs are the costs which are incurred at corporate level and allocated to division based on a specified measure. For example, corporate overheads may be allocated based on sales. Some expenses which are incurred at corporate level like Advertising, CSR, etc may be allocated to division on an agreed basis. These costs are not direct costs associated with division and they are uncontrollable costs. Managers cannot influence these costs to get the results of the division.

Hence companies while rewarding managers based on performance at end of the period should be wary of these allocated costs of the division. The appraisal should be based on costs which are within the control of the division. Performance should be monitored based on directly traceable costs of division and segment margin to ensure expected results are delivered.

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