15 26 allocation of common costs hall auto sales uses

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15-26 Allocation of common costs. Hall Auto Sales uses all types of media to advertise its products (television, radio, newspaper, and so on). At the end of 2016, the company president, Tina Hall, decided that all advertising costs would be incurred by corporate headquarters and allocated to each of the company’s four sales locations based on number of vehicles sold. Tina was confident that her corporate purchasing manager could negotiate better advertising contracts on a corporate-wide basis than each of the sales managers could on their own. Tina budgeted total advertising cost for 2017 to be $1.7 million. She introduced the new plan to her sales managers just before the New Year. The manager of the east sales location, Lee Chan, was not happy. He complained that the new allocation method was unfair and would increase his advertising costs significantly over the prior year. The east location sold high volumes of low-priced used cars and most of the corporate advertising budget was related to new car sales. Following Lee’s complaint, Tina decided to take another hard look at what each of the divisions was paying for advertising before the new allocation plan. The results were as follows: Sales Location Actual Number of Cars Sold in 2016 Actual Advertising Cost Incurred in 2016 East 4,620 $ 261,600 West 1,120 392,400 North 3,220 697,600 South 5,040 828,400 14,000 $2,180,000 Required: 1. Using 2016 data as the cost bases, show the amount of the 2017 advertising cost ($1,700,000) that would be allocated to each of the divisions under the following criteria: a. Davenport’s allocation method based on number of cars sold b. The stand-alone method c. The incremental-allocation method, with divisions ranked on the basis of dollars spent on advertising in 2016 2. Which method do you think is most equitable to the divisional sales managers? What other options might President Tina Hall have for allocating the advertising costs? SOLUTION (20-25 min. ) Allocation of common costs. 1. a. Tina’s method based on number of cars sold: Sales Location (1) Number of cars sold (2) Percentage (3) = (2) ÷ 14,000 Joint Cost (4) Allocation (5) = (3) × (4) East 4,620 4,620 ÷ 14,000 = 0.33 $1,700,000 $ 561,000 West 1,120 1,120 ÷ 14,000 = 0.08 1,700,000 136,000
11 North 3,220 3,220 ÷ 14,000 = 0.23 1,700,000 391,000 South 5,040 5,040 ÷ 14,000 = .36 1,700,000 612,000 14,000 $1,700,000 1. b. Stand-alone method: Sales Location (1) Stand-alone cost (2) Percentage (costs in thousands) (3) = (2) ÷ $2,180 Joint Cost (4) Allocation (5) = (3) × (4) East $ 261,600 $261.6 ÷ $2,180 = 0.12 $1,700,000 $ 204,000 West 392,400 $392.4 ÷ $2,180 = 0.18 1,700,000 306,000 North 697,600 $697.6 ÷ $2,180 = 0.32 1,700,000 544,000 South 828,400 $828.4 ÷ $2,180 = 0.38 1,700,000 646,000 $2,180,000 $1,700,000 1. c. Incremental method (locations ranked in order of largest advertising dollars to smallest advertising dollars): Sales Location Allocated Cost Cost Remaining to Allocate South $ 828,400 ($1,700,000 – $828,400 = $871,600) North 697,600 ($ 871,600 – $697,600 = $174,000) West 174,000 ($ 174,000 – $174,000 = $ 0) East 0 $1,700,000 2. In this situation, the stand-alone method is probably the best method because the weights it uses for allocation are based on the individual advertising cost for each location as a separate entity. Therefore, each entity gets the same relative proportion of advertising costs, and each location will have lower total advertising costs. The sales managers would likely not consider the incremental method fair because the locations with the higher

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