Problems And Exercises 2

Running head: PROBLEMS AND EXERCISES #2 1

Problems and Exercises #2

7-18

Budgeted overhead rate = Budgeted overhead/budgeted allocation base

a. Calculate the profitability of each of the three regional offices after allocating the

corporate expenses to the three offices using revenues as the allocation base.

PROBLEMS AND EXERCISES #2 2

The data above was inputted into Microsoft Excel. The table shows that corporate

expenses ($3,780,000) should be apportioned to the regional offices based off of each of their

individual revenues, which means that the net profit should be apportioned in the same way.

b. What is the relative profitability of the three regional offices (first, second, and third

most profitable) after allocating corporate expenses?

After allocating the corporate expenses of the three regional offices, the highest relative

profitability would first be Boston: $737,926, second Atlanta: $301,286, and third Chicago:

$288,588.

c. At the end of last year, ETB acquired a similar ERM consulting firm in San

Francisco. To support the expanded operations, ETB expects to incur an additional

$500,000 of corporate expenses. The following table provides information regarding

the operations of ETB as if the SF office had been part of ETB for the entire year.

Boston

Atlanta

Chicago

San Francisco

Revenue

$3,450,000

2,900,000

3,440,000

3,100,00

Direct cost

1,035,000

1,015,000

1,238,400

1,240,000

PROBLEMS AND EXERCISES #2 3

Own indirect cost

345,000

464,000

584,800

558,000

Calculate the profitability of each of the four regional offices after allocating the total

corporate expenses ($4,280,000) to the four offices using revenues as the allocation base.

The corporate expenses should be apportioned by revenue. The table above includes the

San Francisco regional data. With this acquisition, the company has incurred corporate expenses

in excess of $500,000 with a total of $4,280,000 corporate expenses to be allocated among four

regional offices.

d. What is the relative profitability of the four regional offices (first, second, third, and

fourth most profitable) after allocating corporate expenses?

In ranking relative profitability, first would be Boston: $924,461, second Chicago:

$474,581, third Atlanta: $458,083, and fourth San Francisco: $272,675.

e. Compare the relative profitability of the three original offices (Boston, Chicago, and

Atlanta) before (part b) and after the acquisition of the SF office [part d]. Analyze and

discuss why the relative profitability of the three original offices (Boston, Chicago, and

Atlanta) does or doesn’t change with the acquisition of the SF office.

Before the acquisition of San Francisco, the relative profitability was Boston, Atlanta,

and Chicago. After the acquisition, the relative profitability was Boston, Chicago, Atlanta,

followed by San Francisco. There was a minimal difference between the net profits of Chicago

PROBLEMS AND EXERCISES #2 4

and Atlanta (474,581 and 458,083 respectively) with a $16,498 profit difference. The change

takes into account the excess corporate expenses of $500,000 incurred. This change should be

allocated to the specific unit to which it was acquired. However, they were charged and allocated

to all of the regional offices.

f. Comment on the appropriateness or inappropriateness of ETB’s current cost allocation

methodology.

ETB’s current cost allocation methodology would be deemed as inappropriate. This

would be explained because the fixed overhead rates are allocated based on revenue. Since

revenue is not equal across all regions, especially since some regions make much more than

others, this would be an inappropriate action. In order to create a more appropriate source of cost

allocation methods, the cost pool should be allocated based on the regional activities, and

therefore utilize the cost pool of $4,280,000 rather than the current method and allocate based on

a case-by-case basis and perhaps vary in some cases per region.

8-9

a. Critically evaluate the analysis underlying the pricing decisions of $900 for Q and

$750 for Y.

In the problem, the pricing decisions are incorrect as it takes into account the joint fixed

costs while allocating them to the products and then treating the allocated costs as marginal

costs. The demand curves for the enzymes are PQ = 1,300 - 2Q and PY = 950 - 4Y. The only

costs that should be considered for the pricing decision would be the $200,000 joint cost (fixed

cost), the marginal cost Q of $100, and the marginal cost Y of $150. Q generates a profit of

$80,000 and Y with $10,000 totaling $90,000 but the profit does not take the fixed costs of the

250 ounces that remain unsold into account and only half of the output ends up being sold. The

PROBLEMS AND EXERCISES #2 5

remaining 250 ounces are allocated by calculating [250oz. * ($200,000/500)] which amounts to

$100,000 of the joint costs yet are not included in the $90,000 profit. Therefore, the company is

in fact losing $10,000 per batch after $90,000 - 100,000. If 200 ounces of Q and 50 ounces of Y

are sold, this will yield a contribution margin of:

● ($800 * 200 + $600 * 50)

○ = $190,000

If we subtract the joint cost of $200,000 from this amount, it also results in the $10,000 loss per

batch.

b. What should management do if the cost per batch rises to $225,000

Quantity

Price of

Q $

Price of

Y $

Revenue

of Q $

Inc. cost

of Q $

Total

profit of

Q $

Revenue

of Y $

Inc. cost

of Y $

Total

profit of

Y $

1200

750

60000

5000

55000

37500

7500

30000

100

1100

550

110000

10000

100000

55000

15000

40000

150

1000

350

150000

15000

135000

52500

22500

30000

200

900

150

180000

20000

160000

30000

250

800

N/A

200000

25000

175000

300

700

N/A

210000

30000

180000

In the table, the maximum profit is seen by taking the cost per batch of $200,000 and the

maximum profit after the batch costs of $20,000 which amounts to $220,000 maximum profit.

PROBLEMS AND EXERCISES #2 6

Since the maximum profits of $220,000 does not exceed the cost per batch of $225,000, the firm

should stop producing once the batch costs reach $225,000.

8-22

a. Allocate the three service departments’ costs (HR, accounting, and

Janitorial/Maintenance) to the two patient units (Clinic and Hospital) using the

direct allocation method.

Service

departments

Dept cost

Clinics

Hospital

Total

Human Res.

$1,200

2,000

3,000

5,000

Accounting

$1,600

6,000

4,000

10,000

Janitorial/Maint.

$2,400

150,000

400,000

550,000

Total

$5,200

Service Dept

Human Res.

$1,200

40%

60%

100%

Accounting

$1,600

60%

40%

100%

Janitorial/Maint.

$2,400

27.27%

72.73%

100%

Human Res.

$480

$720

$1,200

Accounting

$960

$640

$1,600

PROBLEMS AND EXERCISES #2 7

Janitorial/Maint

$654.55

$1,745.45

$2,400

Total allocated

cost

$2,094.55

$3,105.45

$5,200

b. Allocate the three service departments’ costs (HR, Acct, and Jan/Maint) to the two

patient units (clinic and hospital) using the step-down allocation method. The order

of the three departments’ is 1) HR, 2) accounting, 3) Jan/Maint.

Service Dept

Dept cost

Acct

Jan/Maint

Clinics

Hospital

Total

$1,200

$50

$150

2000

3000

$5200

Acct

$1600

$50

$100

6000

4000

$10100

Jan/Maint

$2400

$8000

$9000

150000

400000

550000

Total

$5200

Step Down Allocation

$1200

0.96%

2.88%

38.46%

57.69%

100%

$11.54

$34.62

$461.54

$692.31

$1200

Acct

(1600 +

11.54) =

0.99%

27.27%

72.73%

100%

PROBLEMS AND EXERCISES #2 8

$1611.54

$15.96

$957.35

$638.23

$1611.54

Jan/Maint

(2400 +

34.62 +

15.96) =

$2450.57

27.27%

72.73%

100%

$668.34

$1782.23

$2450.57

Total

allocated

cost

$2087.23

$3112.77

$5200

c. What are the primary advantages of the step-down method compared to the direct

allocation method?

“Step-down cost accounting (SDCA) offers a relatively simple method for generating

cost and unit cost data at the facility level” (Conteh & Walker, 2004). The steps of the step-down

method include defining the final product, defining cost centers, identifying the full cost of each

input, assigning inputs to cost centers, allocating all costs to final cost centers, computing total

and unit costs for each final cost center, and reporting the results. “The step-down method

partially overcomes the problems with direct allocations” (Zimmerman, 2017, pg. 337). This

method allows a breakdown of each of the departments and their use of other departments as

seen in part b. With the direct allocations method, the company would instead allocate the

PROBLEMS AND EXERCISES #2 9

overhead from each of the service departments into the inventory, despite the fact that there is a

presence of cross-costs between the departments (Bank, n.d.). It is a table of all the charges that

each of the departments utilized for the other departments such as Janitorial/Maintenance usage

of Accounting or Accounting use of HR and Janitorial/Maintenance. This method allows

accountability for the work that is done by other departments for other departments so they can

get compensated accordingly. This method gives management a record of the allocation of costs

within the department and gives them an understanding of what service departments may be of

most utility to the company or to other departments.

PROBLEMS AND EXERCISES #2 10

References

Bank, E. (n.d.). The Direct Method of Cost Allocation. Retrieved April 11, 2017 from Chron,

http://smallbusiness.chron.com/advantages-direct-method-cost-allocation-66081.html

Conteh, L., & Walker, D. (2004). Cost and unit cost calculations using step-down accounting.

Health, Policy and Planning, 19(2). 127-135.

Zimmerman, J. (2017). Accounting for Decision Making and Control (4

ed.). New York, NY:

McGraw-Hill Education.

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