Issues in Allocating Corporate Costs to Divisions and Customers
Astel’s management team makes several choices when accumulating and allocating corporate costs to divisions. We present two such issues next.
When allocating corporate costs to divisions, should Astel allocate only corporate costs that vary with division activity or assign fixed costs as well? Astel’s managers allocate both variable and fixed costs to divisions and then to customers because the resulting costs are useful for making long-run strategic decisions, such as which customers to emphasize and what prices to offer. To make good long-run decisions, managers need to know the cost of all resources (whether variable or fixed in the short run) required to sell products to customers. Why? Because in the long run, firms can manage the levels of virtually all of their costs; very few costs are truly fixed. Moreover, to survive and prosper in the long run, firms must ensure that the revenues received from a customer exceed the total resources consumed to support the customer, regardless of whether these costs are variable or fixed in the short run.
At the same time, companies that allocate corporate costs to divisions must carefully identify relevant costs for specific decisions. Suppose a division is profitable before any corporate costs are allocated but “unprofitable” after allocation of corporate costs. Should the division be closed down in the short run? The relevant corporate costs in this case are not the allocated corporate costs but only those corporate costs that will be saved if the division is closed down. If division profits exceed the relevant corporate costs, the division should not be closed.
When allocating costs to divisions, channels, and customers, how many cost pools should Astel use? One extreme is to aggregate all costs into a single cost pool. The other extreme is to have numerous individual cost pools. As discussed in Chapter 5, a major consideration is to construct homogeneous cost pools so that all costs in a cost pool have the same or similar cause-and-effect or benefits-received relationship with the cost-allocation base.
For example, when allocating corporate costs to divisions, Astel can combine corporate advertising costs and corporate administration costs into a single cost pool if both cost categories have the same or similar cause-and-effect relationship with the same cost-allocation base. If, however, as is the case here, each cost category has a cause-and-effect or benefits-received relationship with a different cost-allocation base (for example, revenues of each division benefit from corporate advertising costs whereas corporate administration costs support the administration costs of each division), the company should maintain separate cost pools for each of these costs. Determining homogeneous cost pools requires judgment and should be revisited on a regular basis.
Managers must balance the benefit of using a multiple cost-pool system against the costs of implementing it. Advances in information-gathering technology make it more likely that multiple cost-pool systems will pass the cost–benefit test.