Help me answer this please LO22-1, LO22-2, LO22-4 CASE 22.1 Allocating Fixed Cos

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Help me answer this please

LO22-1, LO22-2, LO22-4 CASE 22.1 Allocating Fixed Costs to Responsibility Centers You have just been hired as the controller of Land's End Hotel. The hotel prepares monthly respon- sibility income statements in which all fixed costs are allocated among the various profit centers in the hotel, based on the relative amounts of revenue generated by each profit center Robert Chamberlain, manager of the hotel dining room, argues that this approach understates the profitability of his department. "Through developing a reputation as a fine restaurant, the din- ing room has significantly increased its revenue. Yet the more revenue we earn, the larger the percentage of the hotel's operating costs that are charged against our department. Also, whenever vacancies go up, rental revenue goes down, and the dining room is charged with a still greater percentage of overall operating costs. Our strong performance is concealed by poor performance in departments responsible for keeping occupancy rates up." Chamberlain suggests that fixed costs relating to the hotel should be allocated among the profit centers based on the number of square feet occupied by each department. Debra Mettenburg, manager of the Sunset Lounge, objects to Chamberlain's proposal. She points out that the lounge is very big, because it is designed for hotel guests to read, relax, and watch the sunset. Although the lounge does serve drinks, the revenue earned in the lounge is small in relation to its square footage. Many guests just come to the lounge for the free hors d'oeuvres and don't even order a drink. Chamberlain's proposal would cause the lounge to appear unprofi- able, yet a hotel must have some "open space" for its guests to sit and relax Instructions With a group of students a. Separately evaluate the points raised by each of the two managers. b. Suggest an approach to allocating the hotel's fixed costs among the various profit centers

Explanation / Answer

(a).

Arguments of each manager looks correct because manager of dining room is correct on his point because due to overburden of fixed costs will affect overall profitability of this department. Thus controller of Land’s End Hotel should consider arguments of the manager of dining room. Because allocation of the fixed costs on the basis of revenues earned by the department will more in case of more revenue thus it will create overburden of fixed costs on dining room department that is why manager is right on his arguments.

Now look at the argument of manager of the sunset lounge. Debra Mettenburg is also correct because due to large area used by this department fixed costs will be more and it is also given that revenues are very less in compare to area used by this department. That is why fixed costs allocation is not looking good for this department. It is given that areas used by this department are being used for various purpose that is why if fixed costs are allocated on the basis of total area used then total allocated fixed costs will be high for this department and as a result overall profitability of this department will be badly affected. Thus controller of Land’s End Hotel should consider arguments of Debra Mettenburg.

(b).

Controller of Land’s End Hotel should focuss on the actual cost drivers that are main cause of the costs and also should identify the connection of these costs centres with relevant deapartments so that actual fixed costs should be allocated to relevant department.

As we know that if fixed costs are allocated on the basis of revenues then performance of department will be affected and high revenue generating department will be demotivated for generating more revenues and low performing department will be much lazy because manager of that department will not be motivated for good performance due to low allocated fixed costs.

So controller should clearly identify costs of idle areas to cocerned department so that no department can complain about overburden of fixed costs. Thus as a result we can say that controller should try to find out true cost centers for each department so that real & actual fixed costs can be allocated to each department and no department can be badly affected.

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