A company has two major businesses that it operates. One business manufactures and sells unicycles for commercial use in circuses, etc. (total sales of $150M), and the other sells bicycles to the public (total sales of $20M). The unicycle business occupies 75,000 square feet of the manufacturing warehouse and the bicycle business occupies the remaining 25,000 square feet. Cost were split 50-50 between the 2 businesses for advertising (total advertising expense of $5M) and warehouse expense (total warehouse expense of $3M) in the past (traditional method).
1. What was the cost of advertising and warehouse expense allocated to each of the business based on the traditional method?
2. What recommendation would you make in allocating these expenses to each of the business and how much would be allocated to each business?
3. What would be some of the issues of too many expenses or too little expenses being allocated to each of the businesses?
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1. To determine the cost of advertising and warehouse expenses allocated to each of the businesses based on the traditional method, we need to divide the expenses evenly between the two businesses.
a) Cost of advertising expenses:
Total advertising expense = $5M.
Since the cost was split 50-50 between the two businesses, each business would be allocated half of the total advertising expense.
Allocated advertising expense per business = $5M / 2 = $2.5M.
b) Cost of warehouse expenses:
Total warehouse expense = $3M.
Similarly, since the cost was split 50-50, each business would be allocated half of the total warehouse expense.
Allocated warehouse expense per business = $3M / 2 = $1.5M.
Therefore, based on the traditional method, the unicycle business would have an allocated advertising expense of $2.5M and an allocated warehouse expense of $1.5M. Similarly, the bicycle business would also have an allocated advertising expense of $2.5M and an allocated warehouse expense of $1.5M.
2. In recommending an allocation of expenses to each of the businesses, we should consider the specific needs and revenue contributions of each business unit.
a) Advertising expenses recommendation:
Since the unicycle business has higher total sales ($150M) compared to the bicycle business ($20M), it may make sense to allocate a larger proportion of the advertising expenses to the unicycle business. This could be done based on the proportion of sales generated by each business. For example, if the unicycle business contributes 75% of the total sales and the bicycle business contributes 25%, we could allocate 75% of the advertising expenses to the unicycle business and 25% to the bicycle business.
b) Warehouse expenses recommendation:
Similarly, we can consider the space occupied by each business as a basis for allocating warehouse expenses. As the unicycle business occupies 75,000 square feet (75% of the total warehouse space), it may be appropriate to allocate 75% of the warehouse expenses to the unicycle business, and the remaining 25% to the bicycle business.
The exact allocation percentages and amounts may vary based on the specific circumstances and strategies of the company. It would be beneficial to analyze factors such as contribution to total sales, space usage, profitability, or other relevant metrics to make a more accurate recommendation.
3. Issues of too many or too little expenses allocated to each business:
a) Too many expenses:
If one business is allocated a disproportionate amount of expenses, it may result in reduced profitability for that business. This could lead to financial challenges, decreased competitiveness, and potential budget constraints for the business unit. It can also lead to an unfair burden on the business that is allocated a larger portion of the expenses.
b) Too little expenses:
Allocating too little expenses to a business might result in inadequate resources to support its operations effectively. This could adversely affect the business's ability to generate revenue, fulfill customer demands, or invest in growth opportunities. It could create an imbalance between the actual costs incurred by the business and the resources allocated for its operations.
Properly allocating expenses to each business helps maintain fairness, accuracy, and optimal resource utilization. It ensures that each business is accountable for its own costs and resources, leading to better decision-making and performance evaluation.