1. What was the cost of advertising and warehouse expense allocated to each of the business based on the traditional method?

In this case there are two businesses unicycle and bicycle business, the costs are split 50-50 between the two, Advertising expense is 5m, Warehouse expense is 3M and therefore total cost = 5M + 3M = 8M.Using the traditional method the costs are split 50-50 between the two, and therefore each business was allocated 4 million each in costs.

2. What recommendation would you make in allocating these expenses to each of the business and how much would be allocated to each business?

An Activity based costing would be more appropriate in allocation of costs. Activity based costing according to Drury, C. (2000) refers to a method of costing that involves the allocation of costs using cost drivers, costs drivers are activities that are used to allocate costs, according to Stratton (2002) warehouse cost can be allocated using the area as a cost driver. Total area of the warehouse is 75,000 + 25,000 = 100,000, Total warehouse expense is 3 million, therefore cost per square feet will be determined by dividing the cost by total area, 3 m/100,000 = 30, therefore cost per square feet is $30. Using this rate the warehouse cost is allocated depending on area as follows:

Unicycle business warehouse cost=75000*30=2,250,000

Bicycle business warehouse cost=25000*30=750,000

Therefore the unicycle business warehouse cost is 2,250,000 while bicycle business warehouse cost should be 750,000.

According to Weetman (2002) the appropriate cost driver for advertising costs is sales, sales for both businesses amount to (bicycles) 20m+ (unicycles) 150m = 170m, total advertising costs amount to 5m and therefore advertising cost per sales unit = 5/170 = 0.029412

Unicycle business advertising cost=150,000,000*0.029412=4,411,765

Bicycle business advertising cost=20,000,000*0.029412=588,235

Therefore 4.411 million of advertising cost should be allocated to the unicycle business and 0.588 million allocated to the bicycle business. The table below summarizes the costs allocated to each business:

warehouse cost

advertising cost

total

unicycle business

2,250,000

4,411,765

6,661,765

bicycle business

750,000

588,235

1,338,235

total

3,000,000

5,000,000

8,000,000

3. What would be some of the issues of too many expenses or too little expenses being allocated to each of the businesses?

The activity based method offers a more accurate method of cost allocation, these aids in performance management of each business which will be hard to determine when the traditional method is used. Also the allocation of costs using the traditional method may lead to disadvantages whereby the company may fail to be competitive in the market given that one business is allocated more expenses, it is also evident that using the traditional method 4 million of costs were allocated to the bicycle business whereas using the activity based costing method the cost is 1.338, this may explain why there is a higher sales level in the unicycle business than the bicycle industry.

References:

Drury, C. (2000) Management and cost accounting, New York: McGraw hill

Sundem, G. and Stratton, W. (2002) Introduction to management accounting, New Jersey: Prentice hall

Weetman, P. (2002) Management Accounting: An Introduction accounting, New York: McGraw hill

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