Allocation of central corporate costs to divisions. Dusty Rhodes, the corporate controller of the Richfield Oil Company, is about to make a presentation to the senior corporate execu¬

tives and the top managers ofits four divisions. These divisions are

a. Oil and Gas Upstream (the exploration, production, and transportation of oil and gas)

b. Oil and Gas Downstream (the refining and marketing of oil and gas)

c. Chemical Products

d. Copper Mining Under the existing internal accounting system, costs incurred at central corporate headquarters are collected in a single pool and allocated to each division on the basis ofthe actual revenues of each division. The central corporate costs (in millions) for the most recent year are as follow's:

Interest on debt $2,300 Corporate salaries 100 Accounting and control 100 General marketing 100 Legal 100 R&D 200 Public affairs 208 Human resources and payroll 192

$3,300

“Public affairs” includes the public relations staff, the lobbyists, and the sizable donations Richfield makes to numerous charities and not-for-profit institutions.

Summary data (in millions) related to the four divisions for the most recent year are as follows:

Oil and Gas Upstream Oil and Gas Downstream Chemical Products Copper Mining Total Revenue $ 7,000 $16,000 $4,000 $3,000 $30,000 Operating costs $ 3,000 $15,000 $3,800 $3,200 $25,000 Operating income $ 4,000 $ 1,000 $ 200 $ (200) $ 5,000 Identifiable assets $14,000 $ 6,000 $3,000 $2,000 $25,000 Number of employees 9,000 12,000 6,000 3,000 30,000 1 he top managers of each division share in a divisional income bonus pool. Divisional income is defined as operating income less allocated central corporate costs.

Rhodes is about to propose a change in the method used to allocate central corporate costs. He favours collecting these costs in four separate pools:

Cost pool 1. Allocated using identifiable assets of division Cost Item: Interest on debt Cost pool 2. Allocated using revenue of division Cost Items: Corporate salaries, accounting and control, general marketing, legal, R&D Cost pool 3. Allocated using operating income (if positive) of division, with only divisions with positive operating income included in the allocation base Cost Item: Public affairs Cost pool 4. Allocated using number of employees in division Cost Item: Human resources and payroll Required 1. What purposes might be served by the allocation of central corporate costs to each division at Richfield Oil?

2. Compute the divisional income of each of the four divisions when central corporate costs are allocated using revenue of each division.

3. Compute the divisional income of each ofthe four divisions when central corporate costs are allocated through the four cost pools.
4. What are the strengths and weaknesses of Rhodes’s proposal relative to the existing single¬
pool method?