The company is organized into two lines of business (software and consulting), and profit statements are prepared as follows:
Software Consulting
Sales $10,000,000 $5,000,000
Less direct costs 5,000,000 3,000,000
Less allocated costs 3,000,000 1,000,000
Income before taxes 2,000,000 1,000,000
direct costs include costs that are easily associated with each line of business. For software, this includes the salary of programmers, the cost of computers used by programmers, and the cost of CDs sold to customers. For consulting, direct costs include are not directly traced to business units. These costs include employee benefits, rent, tell comm costs, and general and admin costs such as the salary of the CEO
At the start of 2008, allocated costs were estimated as follows:
Employee benifits $1,000,000
Rent 600,000
Tell Comm 400,000
General and admin costs 2,000,000
Total 4,000,000
in the past allocations have been based on headcount. Software had 300 employees and consulting had 100 employees. The new controller of the company believes that the key driver of employee benefits and tell comm costs is headcount. However, rent is driven by space occupied, and general and admin costs are driven by relative sales. The company's rents 30,000 square feet; approx. 15,000 is occupied by software employees and 15,000 by consulting personnel.
1. Prepare profit reports for software and consulting assuming the company allocates costs using headcount, space occupied, and sales as allocation bases. Compare the new levels of profit to the levels that result using a single allocation base (headcount).
2. Which provides the best information on profitability - a single overhead cost pool with headcount as the allocation base, or multiple cost pools using headcount, sales, and space occupied?