Critical Thinking Cases

You have just been hired as the controller of Land’s End Hotel. The hotel prepares monthly responsibility 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 unprofit- 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.