What was the cost of advertising and warehouse expense allocated to each of the businesses based on the traditional method?
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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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a) Under traditional system cost is allocated as 50-50 basis
Unicycles Bicycles
Cost of Advertising =$5m*50%=2.5 million =$5m*50%=2.5 million
Warehouse Expenses =$3m*50%=$1.5 million =$3m*50%=$1.5 million
Total Overhead allocated = $4.0 million =$4 million
b) The recommended method is to allocate the costs based on the activities used by the different businesses. For example the cost driver for advertising is sales volume and for warehousing ...
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