Allocation & Costs

Question 1

The net profit of each section by not allocating non-traceable expenditure to each section is portrayed below

Profit Statement

New York '000

Chicago '000

Paris '000 Little

Rock '000

Revenue from billings 22 ,000 10 ,000 16 ,000 2 ,000

Traceable Consulting Costs 14 ,000 6 ,000 12 ,500 1 ,000

Gross profit on Sales 8 ,000 4 ,000 3 ,500 1 ,000

Traceable Other Costs 300 200 500 0

Net income 7 ,700 3 ,800 3 ,000 1 ,000 Question 2

A drastic

difference can be noted in the net income through the removal of non-traceable costs from the income statement . It is pertaining to conduct a detailed examination of such new profit in to point any valid factors , which may eventually affect the performance of the division

The area in which the highest percentage movement is noted encompasses those that hold the largest billing revenue . These comprise the New York and Paris area . Indeed , the gross profit margin of the New York division increase by 122 .22 with the removal of non-traceable costs while that of the Paris section rose by 1 ,066 .67

Question 3

Goal congruence is a very important principle that an organisation that hold different divisions like Creative Consumer Consultants Ltd . should try to achieve . This is indeed an important element that enhances the effectiveness of the firm . Through the allocation of non-traceable costs such objective may be deterred . This is particularly in light of the bonus scheme enacted on departmental managers by top management Even though such bonus scheme was installed to stimulate efficiency in the organisation , the allocation of non-traceable costs stems from sales revenue . Therefore departmental management may limit s to keep sales at a particular balance that limits excessive non-traceable expenditure . This is of particular concern to the Paris Division that is performing losses of 1 million due to non-traceable costs . Thus the positive effect induced by the bonus scheme is being offset through the application of non-traceable expenses . Such factor will eventually refrain the company from attaining goal congruence in its main objective of enhancing the financial performance of each division

This allocation problem also induces a demotivation effect on departmental managers . If the financial performance of the section will not be penalized from non-traceable costs , which are normally outside the control of departmental managers , managers will work harder to enhance the sales revenue to increase the net profit of the area and enhance the bonus attained . Therefore such demotivation is also hindering the organization in reaching its main objective

A viable suggestion to such problem is the adopting of a pricing technique like transfer pricing . If pricing decisions are left in the hands of departmental managers , there is the risk that a low price with a low profit margin is charged in to penetrate the market and increase the performance bonus . This agency problem may therefore stimulate a poor financial performance for the company , since the non-traceable costs that should also be covered to...