A company has two major businesses that it operates. One business manufactures and sells unicycles for commercial use in circuses and so forth (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 businesses based on the traditional method?
2. What recommendation would you make in allocating these expenses to each of the businesses, 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?
1. To determine the cost of advertising and warehouse expenses allocated to each of the businesses based on the traditional method, we need to follow these steps:
Step 1: Calculate the total square footage allocated to each business
In this case, the unicycle business occupies 75,000 square feet, and the bicycle business occupies the remaining 25,000 square feet. Therefore, the total allocated square footage is 75,000 + 25,000 = 100,000 square feet.
Step 2: Calculate the ratio of square footage for each business
For the unicycle business: 75,000 / 100,000 = 0.75 (or 75%)
For the bicycle business: 25,000 / 100,000 = 0.25 (or 25%)
Step 3: Allocate the total advertising and warehouse expenses to each business based on the ratios calculated
For advertising expenses: 0.75 * $5M = $3.75M for the unicycle business, and 0.25 * $5M = $1.25M for the bicycle business.
For warehouse expenses: 0.75 * $3M = $2.25M for the unicycle business, and 0.25 * $3M = $0.75M for the bicycle business.
Therefore, according to the traditional method, the cost of advertising and warehouse expense allocated to each business would be as follows:
- Unicycle Business: Advertising - $3.75M, Warehouse - $2.25M
- Bicycle Business: Advertising - $1.25M, Warehouse - $0.75M.
2. In recommending a new allocation method for these expenses, it is important to consider the key factors that contribute to the usage and benefit derived from advertising and warehouse space for each business.
For example, if it can be determined that the unicycle business benefits more from advertising and requires a larger amount of warehouse space compared to the bicycle business, a new allocation method could reflect this by assigning a higher percentage of expenses to the unicycle business.
Similarly, if the bicycle business is growing rapidly and requires additional investment in advertising and warehouse space, it may be appropriate to allocate a larger portion of the expenses to the bicycle business.
Ultimately, the recommendation for allocating these expenses should be based on a thorough analysis of the specific needs and benefits of each business.
3. Issues of too many or too few expenses being allocated to each business can have several potential impacts:
a) Overallocation of expenses: If one business is allocated an excessive amount of expenses compared to its revenue or cost structure, it may face financial burdens that could hinder its profitability. This could result in reduced investment in growth or difficulty in competing with rivals in the market.
b) Underallocation of expenses: On the other hand, if one business is allocated too few expenses relative to its needs, it might not have sufficient resources to support its operations effectively. This can lead to inadequate market presence, decreased competitiveness, and potential missed growth opportunities.
c) Misrepresentation of profitability: The allocation of expenses directly impacts the profitability of each business. If expenses are misallocated, it can distort the financial performance of each business, making it difficult to accurately assess its profitability and make informed strategic decisions.
Therefore, it is crucial to carefully consider the specific requirements and circumstances of each business when allocating expenses to ensure fairness, accuracy, and optimal operational performance.