A legal services firm processes routine documents for law firm clients in Ohio and Kentucky. Since Indiana law and procedures are similar, it is considering adding clients from that state. In making this decision, the company “allocates” one-third of its existing overhead to the new Indiana “division,” since it is expected to be about one-third of the total operation.
Total company overhead (annualized, pre expansion): $9 million
Revenue minus variable costs, Kentucky/Ohio division: $12 million
Expected Indiana revenue: $6 million
Expected additional costs of Indiana division: $4 million
(a) What is the Indiana division “profit” using the company’s required allocation of costs?
(b) Is this the correct decision for the profit of the organization? What is the appropriate criteria and decision?