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14-18 (Cont’d.)

B: Cost allocation based on floor space:

    Hotel

Restaurant

  Casino

Rembrandt

Allocated indirect costs

$7,275,000

$1,455,000

$5,820,000

$14,550,000

Segment pre-tax income

$  (669,260)

$     51,828

$2,271,232

$  1,653,800

Segment pre-tax income %

      -4.07%

       0.99%

     18.41%

C: Cost allocation based on # of employees

    Hotel

Restaurant

  Casino

Rembrandt

Allocated indirect costs

$5,820,000

$1,455,000

$7,275,000

$14,550,000

Segment pre-tax income

$   785,740

$     51,828

$   816,232

$  1,653,800

Segment pre-tax income %

       4.78%

       0.99%

       6.61%

3.

The segment pre-tax income percentages show the dramatic effect of choice of the cost allocation base on reported numbers:

Denominator

Hotel

Restaurant

Casino

Direct costs

-8.60%

  -29.58%

37.45%

Floor space

-4.07

      0.99

18.41

# of employees

4.78

      0.99

  6.61

The decision context should guide a. whether costs should be allocated, and b. the preferred cost allocation base.  Decisions about, say, performance measurement may be made on a combination of financial and nonfinancial measures.  It may well be that Rembrandt may prefer to exclude allocated costs from the financial measures to reduce areas of dispute.

Where cost allocation is required, the cause-and-effect and benefits-received criteria are recommended in Chapter 14.  The $14,550,000 is a fixed overhead cost.  This means that on a short-run basis, the cause-and-effect criterion is not appropriate but Rembrandt could attempt to identify the cost drivers for these costs in the long run when these costs are likely to be more variable. Rembrandt should look at how the $14,550,000 cost benefits the three divisions.  This will help guide the choice of an allocation base in the short run.

4.  The analysis in requirement 2 should not guide the decision on whether to shut down any of the divisions. The overhead costs are fixed costs in the short run. It is not clear how these costs would be affected in the long run if Rembrandt shut down one of the divisions. Also, each division is not independent of the other two. A decision to shut down, say, the restaurant likely

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