Based on the traditional method, the unicycle and the bicycle businesses both shoulder costs in the total amount of 4 million each, which is comprised of 2.5 million in advertising and 1.5 million in warehouse expense (see Figure 1).

            The traditional method allocates the costs equally, without regard for the reason behind such an expense. An allocation base should be used that is a cost driver (which is defined as a factor such as machine hours or beds occupied that causes the cost) of the expense (Garrison & Noreen 2000). The base used should “drive” the costs, otherwise the data produced will be inaccurate and will not serve as a good basis for decision making. Hence, the warehouse expense should be allocated using the square foot occupied by the particular business while the advertising cost is still divided equally, under the assumption that both businesses are promoted equally.  Using this alternative method, the unicycle business will have a total cost of 4.75 million, broken downs as follows: 2.5 million in advertising and 2.25 million in warehouse expense. The bicycle business on the other hand will have 2.5 million in advertising and 750 thousand in warehouse expense, for a total cost of 3.25 million. See Figure 2.

            As earlier mentioned, the inaccurate manner of allocating costs will produce information unfit for decision making.  The implications of this are significant. The most important is that the true profitability of the businesses will be obscured. One business may appear to be more profitable than the other when in reality, it is the other way around. This will in turn affect the decision of the management in the production and marketing of these products, even the expansion or discontinuance of such business lines. In the present case, the bicycle business was overallocated by 750 thousand (see Figure 3). The negative impact of this in the profitability of the bicycle business is more significant since its sales is smaller in amount. Errors such as this could have prompted management to discontinue an otherwise profitable venture.
Appendix 1: Computations

traditional method

UNICYCLE
BICYCLE
square feet occupied

75,000
25,000
total advertising
5,000,000

total warehouse
3,000,000

sales

150,000,000
20,000,000
less costs

advertising

2,500,000
2,500,000

warehouse

1,500,000
1,500,000

4,000,000
4,000,000
net income

146,000,000
16,000,000
Figure 1. Income and expenses under the traditional method.

alternative method

UNICYCLE
BICYCLE
square feet occupied

75,000
25,000
total advertising
5,000,000

total warehouse
3,000,000

sales

150,000,000
20,000,000
less costs

advertising

2,500,000
2,500,000

warehouse

2,250,000
750,000

4,750,000
3,250,000
net income

145,250,000
16,750,000
Figure 2. Income and expenses under the activity based method.

difference

UNICYCLE
BICYCLE
advertising cost under the traditional method
2,500,000
2,500,000
advertising cost under the alternative method
2,500,000
2,500,000

–
–
warehouse cost under the traditional method
1,500,000
1,500,000
advertising cost under the alternative method
2,250,000
750,000

(750,000)
750,000
total difference

(750,000)
750,000
Figure 3. Differences between the expenses computed under the traditional and activity based method

.
References

Garrison, R. H., & Noreen, E. W. (2000). Managerial Accounting Ninth Edition. United States of America: Irwin McGraw-Hill.