Question: Loretto Outfitters is a retail chain of
Loretto Outfitters is a retail chain of stores organized into two divisions (East and West) and a corporate headquarters. Corporate planners have prepared financial operating plans (budgets) for the two divisions for the upcoming year (year 2). Selected information from the plans is as follows:
Based on information from various corporate staff, the planning team estimates that corporate overhead costs are expected to be $20 million in year 1. Of the $20 million, $7.2 million is fixed and the remainder is variable. With respect to the variable overhead, $4.8 million is variable with respect to revenue and the remainder is variable with respect to the number of stores. The two division managers are evaluated and compensated in part on division operating profit (including any allocated corporate costs) relative to the budget. Corporate overhead at Loretto is allocated based on relative revenues to determine both budgeted and actual operating profit.
Required
a. What are the budgeted operating profits in each division for year 1 after the corporate costs are allocated?
b. At the end of year 1, actual corporate costs incurred were $19 million. Of the $19 million, $7.3 million was fixed, $4.5 million was variable with respect to revenues, and $7.2 million was variable with respect to the number of stores. Actual division results in year 1, prior to any allocation, are as follows:
What are the actual (reported) operating profits in each division for year 1 after the corporate costs are allocated?
c. Comment on the results from requirements (a) and (b).
d. Recommend a corporate cost allocation system that would address the issues you raised in requirement (c). Illustrate your recommendation by calculating the actual division operating profits using your recommended allocation system.
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