C cost justification or reimbursement some lines of

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Cornerstones of Cost Management
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Chapter 11 / Exercise 11.19
Cornerstones of Cost Management
Hansen/Mowen
Expert Verified
c.Cost justification or reimbursement. Some lines of business of Richfield Oil may be regulated with cost data used in determining “fair prices”; allocations of central corporate costs will result in higher prices being set by a regulator. d. Income measurement for external parties.Richfield Oil may include allocations of central corporate costs in its external line-of-business reporting. 2. Oil & Gas Upstream Oil & Gas Downstream Chemical Products Copper Mining Total Revenues $8,000 $16,000 $4,800 $3,200 $32,000 Percentage of revenues $8,000; $16,000; $4,800; $3,200 ÷$32,000 25% 50% 15% 10% 100% (Dollar amounts in millions) Oil & Gas Upstream Oil & Gas Downstream Chemical Products Copper Mining Total Revenues $8,000 $16,000 $4,800 $3,200 $32,000 Operating costs 3,000 15,000 3,800 3,500 25,300 Operating income 5,000 1,000 1,000 (300) 6,700 Corp. costs allocated on revenues (% of revs ×$3,228) 807 1,614 484 323 3,228 Division operating income $4,193 $ (614) $ 516 $ (623) $ 3,472
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Chapter 11 / Exercise 11.19
Cornerstones of Cost Management
Hansen/Mowen
Expert Verified
14-23 3. First, calculate the share of each allocation base for each of the four corporate cost pools: Oil & Gas Upstream Oil & Gas Downstream Chemical Products Copper Mining Total Identifiable assets $14,000 $6,000 $3,000 $2,000 $25,000 (1)Percentage of total identifiable assets $14,000; $6,000; $3,000; $2,000 ÷$25,000 56% 24% 12% 8% 100% Division revenues $8,000 $16,000 $4,800 $3,200 $32,000 (2) Percentage of total division revenues $8,000; $16,000; $4,800; $3,200 ÷$32,000 25% 50% 15% 10% 100% Positive operating income $5,000 $1,000 $1,000 NONE $7,000 (3) Percentage of total positive operating income $5,000; $1,000; $1,000; 0 ÷$7,000 71.4% 14.3% 14.3% 0% 100% Number of employees 9,000 12,000 6,000 3,000 30,000 (4) Percentage of total employees 9,000; 12,000; 6,000; 3,000 ÷30,000 30% 40% 20% 10% 100% Using these allocation percentages and the allocation bases suggested by Rhodes, we can allocate the $3,228 M of corporate costs as shown below. Note that the costs in Cost Pool 2 total $800 M ($150 + $110 + $200 + $140 + $200). (Dollar amounts in millions) Oil & Gas Upstream Oil & Gas Downstream Chemical Products Copper Mining Total Revenues $8,000.00 $16,000.00 $4,800.00 $3,200.00 $32,000 Operating Costs 3,000.00 15,000.00 3,800.00 3,500.00 25,300 Operating Income 5,000.00 1,000.00 1,000.00 (300.00) 6,700 Cost Pool 1 Allocation ((1) ×$2,000) 1,120.00 480.00 240.00 160.00 2,000 Cost Pool 2 Allocation ((2) ×$800) 200.00 400.00 120.00 80.00 800 Cost Pool 3 Allocation ((3) ×$203) 145.00 29.00 29.00 0.00 203 Cost Pool 4 Allocation ((4) ×$225) 67.50 90.00 45.00 22.50 225 Division Income $3,467.50 $ 1.00 $ 566.00 $ (562.50) $ 3,472 4. The table below compares the reported income of each division under the original revenue-based allocation scheme and the new 4-pool-based allocation scheme. Oil & Gas Upstream seems 17% less profitable than before ($3,467.5÷$4,193 = 83%), and may resist the new allocation, but each of the other divisions seem more profitable (or less loss-making) than before and they will probably welcome it. In this setting, corporate costs are relatively large (about 13% of total operating costs), and division incomes are sensitive to the corporate cost allocation method. (Dollar amounts in millions) Oil & Gas Upstream Oil & Gas Downstream Chemical Products Copper Mining Total Operating Income (before corp. cost allocation) $5,000.00 $1,000.00 $1,000.00 $(300.00) $6,700 Division income under revenue-based allocation of corporate costs $4,193.00 $ (614.00) $ 516.00 $(623.00) $3,472 Division income under 4-cost-pool allocation of corporate costs $3,467.50 $ 1.00 $ 566.00 $(562.50) $3,472 Strengths of Rhodes’ proposal relative to existing single-cost pool method:
14-24 a. Better able to capture cause-and-effect relationships. Interest on debt is more likely caused by the financing of assets than by revenues. Personnel and payroll costs are more

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