LMN comprises three trading divisions plus a Head Office. There is a director for each trading division and, in addition, there is a Managing Director who is based in Head Office. Divisional directors are empowered to make decisions concerning the day to day operations of their division and investment decisions requiring an initial investment up to $100,000. Investment decisions involving greater initial expenditure must be authorised by the Managing Director. Inter-divisional trading occurs between all of the trading divisions. The transfer prices are determined by Head Office. Head Office provides services and facilities to each of the trading divisions.
At the end of each month, the actual costs of Head Office are apportioned to the trading divisions. Each Head Office cost is apportioned to the trading divisions using an appropriate basis. The bases used are: number of employees; value of sales; capital invested; and standard hours of service delivered.
The Head Office costs, together with the costs and revenues generated at divisional level, are summarised in a divisional performance statement each month. The divisional directors are not happy with the present performance statement and how it is used to appraise their performance.
Required:
(a) Explain, using examples from the scenario, three issues that LMN should consider when designing a new divisional performance statement. LMN is thinking of introducing Activity Based Costing at its Head Office to help with the apportionment of all its costs to the divisions.
(b) Discuss the advantages of applying Activity Based Costing to apportion all of the Head Office costs.