Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 38

Allocation of Central Costs; Profit centers Holiday Resorts, Inc. operates four resort hotels in the heavily wooded areas of eastern Texas. The resorts are named after the predominant trees at the resort: Oak Glen, Birch Glen, Mimosa, and Walnut Arbor. Holiday allocates its central office costs to each of the four hotels according to the annual revenue it generated. For the current year, these costs (000s omitted) were as follows:

Front office personnel (desk, clerks, etc.)	$ 6,000
Administrative and executive salaries	4,000
Interest on resort purchase	2,000
Advertising	600
Housekeeping	1,000
Depreciation on reservations computer	80
Room maintenance	800
Carpet-cleaning contract	50
Contract to repaint rooms	400
	$14,930

 

	Oak Glen	Walnut Arbor	Birch Glen	Mimosa	Total
Revenue (000s)	$ 4,550	$ 8,975	$ 9,678	$ 6,220	$ 29,423
Square feet	65,122	77,375	38,655	82,556	263,708
Rooms	88	125	64	175	452
Assets (000s)	$88,125	$132,775	$68,545	$55,883	$345,328

Required

1. Based on annual revenue, what amount of the central office costs are allocated to each hotel? What are the shortcomings of this allocation method?

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2. Suppose that the current method were replaced with a system of four separate cost pools with costs collected in the four pools allocated on the basis of revenues, assets invested in each hotel, square footage, and number of rooms, respectively. Which costs should be collected in each of the four pools?

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3. Using the cost pool system in requirement 2, how much of the central office costs would be allocated to each hotel? Is this system preferable to the single-allocation base system used in requirement 1? Why or why not?

Step 1 of 3

Allocation of Central Costs; Profit Centers  (30 min)

1.?Allocation based on revenue

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Note that the allocation based on revenue shown above means that the operating margin (operating margin/revenue) is the same for all four resorts, at 49.3%. Using the revenue-based allocation guarantees this will be the case.

Consider the shortcomings of the method. What causes the usage of each of the types of central office costs? Many of them are not related to revenue; for example, it is unlikely that interest or administrative and executive salaries are closely related to revenue. Also, the cost of front office personnel is likely to be related to same measure of the number of customers of the resort. Perhaps the number of rooms is a better measure of the usage of the cost of front office personnel.