Question

ALLOCATION COSTS TO DIVISIONS
Gether Corporation manufactures appliances. It has four divisions: refrigerator, stove, dishwasher, and microwave oven. Each division is located in a different city and the headquarters is located in Mississauga, Ontario. Headquarters incurs a total of $14,255,000 in costs, none of which are direct costs of any of the divisions. Revenues, costs, and facility space for each division are as follows:
														Refrigerator		Stove		Dishwasher		Microwave Oven
											Revenue			$10,900,000		$18,800,000		$11,500,000		$6,780,000
Direct costs			5,700,000		10,400,000		6,200,000		3,220,000
Segment margin			5,200,000		8,400,000		5,300,000		3,560,000
Square metres of floor space occupied			130,000		90,000		80,000		100,000
Gether wants to allocate the indirect costs of headquarters on the basis of either square metres or segment margin for each division.
Required
Allocate the indirect headquarters costs to each division, first using square metres of space and then using segment margin as the allocation base. Calculate the division operating margins after each allocation in dollars and as a percentage of revenue.
											Which allocation base do you prefer? Why?
											Should any of the divisions be dropped based on your calculations? Why or why not?

Answer 1

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Gether Corporation
Allocation on the basis of square meters
Item	Square meters	Allocation %	Indirect costs	Costs allocated
Refrigerator	130,000.00	32.50%	14,255,000.00	4,632,875.00
Stove	90,000.00	22.50%	14,255,000.00	3,207,375.00
Dishwasher	80,000.00	20.00%	14,255,000.00	2,851,000.00
Microwave Oven	100,000.00	25.00%	14,255,000.00	3,563,750.00
Total	400,000.00	100.00%		14,255,000.00
Income Statement	Refrigerator	Stove	Dishwasher	Microwave Oven
Revenue	10,900,000.00	18,800,000.00	11,500,000.00	6,780,000.00
Less: Direct costs	5,700,000.00	10,400,000.00	6,200,000.00	3,220,000.00
Segment margin	5,200,000.00	8,400,000.00	5,300,000.00	3,560,000.00
Less: Indirect costs	4,632,875.00	3,207,375.00	2,851,000.00	3,563,750.00
Operating margin	567,125.00	5,192,625.00	2,449,000.00	(3,750.00)
Operating margin %	5.20%	27.62%	21.30%	-0.06%
Allocation on the basis of Segment margin
Item	Segment margin	Allocation %	Indirect costs	Costs allocated
Refrigerator	5,200,000.00	21.49%	14,255,000.00	3,063,058.00
Stove	8,400,000.00	34.71%	14,255,000.00	4,948,016.00
Dishwasher	5,300,000.00	21.90%	14,255,000.00	3,121,963.00
Microwave Oven	5,300,000.00	21.90%	14,255,000.00	3,121,963.00
Total	24,200,000.00	100.00%		14,255,000.00
Income Statement	Refrigerator	Stove	Dishwasher	Microwave Oven
Revenue	10,900,000.00	18,800,000.00	11,500,000.00	6,780,000.00
Less: Direct costs	5,700,000.00	10,400,000.00	6,200,000.00	3,220,000.00
Segment margin	5,200,000.00	8,400,000.00	5,300,000.00	3,560,000.00
Less: Indirect costs	3,063,058.00	4,948,016.00	3,121,963.00	3,121,963.00
Operating margin	2,136,942.00	3,451,984.00	2,178,037.00	438,037.00
Operating margin %	19.60%	18.36%	18.94%	6.46%

To drop or not to drop:

Under square feet method Microwave Oven is showing loss. So it should be dropped.

Preferred method is allocation on the basis of segment margin. None of the product is showing loss so no product should be dropped.