2. While we do not favor the allocation of common costs to segments, the
most common reason given for this practice is that segment managers
need to be aware of the fact that common costs do exist and that they
must be covered.
Arguments against allocation of all costs:
• Allocation bases will need to be chosen arbitrarily since no cause-and-
effect relationship exists between common costs and the segments to
which they are allocated.
• Management may be misled into eliminating a profitable segment
that appears to be unprofitable because of allocated common costs.
• Segment managers usually have little control over common costs.
They should not be held accountable for costs over which they have
no control.
• Allocations of common costs undermine the credibility of performance
reports. Segment managers may resent such allocations and ignore
the entire performance report as arbitrary and unfair.
Group Exercise 12-36
The answers to this question will depend on the nature of the financial re-
ports students obtain from their college.
Group Exercise 12-37
Note: This is a very difficult problem that requires an excellent understand-
ing of the course to this point and analytical skills.
The two groups—representing managers in a transfer pricing negotia-
tion— should be able to come to an agreement concerning the transfer
price.
From the standpoint of the Consumer Products Division, a deal with the
Industrial Products Division to acquire the electric motors at the transfer
price “TP” makes sense only if the deal will increase the division’s residual
income over and above what it would be without producing and selling the
new sorbet maker. In other words, the residual income from the sorbet
maker itself, after taking into account the deduction for the cost of the
electric motor, must be positive:
Residual income from the sorbet maker $0
>
Contribution margin - Fixed cost - Minimum required return $0
($89 - $54 - TP) 50,000 - $180,000 - 0.20 $3,000,000 $0
× × >
($35 - TP) 50,000 - $180,000 - $600,000 $0
× >
($
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