Prorating as a Management Tool
Bill is general manager of Everything Retail Inc. (ERI). ERI is organized by Departments. Each Department has a Department Manager whose compensation is directly linked to the Company’s calculation of (their) Departmental profit.
ERI operates from a single large bricks and mortar storefront. Two of the most significant Departments are Jewelry and Sporting Goods. The Department Heads are George – Jewelry, and Monica – Sporting Goods. George and Monica have recently come to Bill to discuss a heated issue between them. Assume that the “other” Departments are a collection of smaller operations whose Department Heads are not involved in this issue.
One of ERI’s major expenses is the monthly rent of $25,000. When calculating departmental profit, Bill has allocated the monthly rent cost to each Department, prorated based on the following data (which is not in dispute):
George is quite unhappy. He argues that it is unfair for his Department (Jewelry) to bear almost 50% of the cost of space. He has produced the following space related data and argues that he should only be burdened with the relative cost of the space occupied by his department.
|Jewelry||600 square feet|
|Sporting Goods||2500 square feet|
|Others||1000 square feet|
- In mathematical terms express the monthly share of rent assigned to each Department group under Bill’s approach and under George’s approach. Your formula should produce the differential impact of each approach on each Department group in terms of rent share as a percentage of Departmental monthly sales.
- Create an Excel spreadsheet with appropriate formulas that calculate the allocation of rent costs and the differential impact to each Department based on the two approaches.
Prepare a written response to the following argument:
“Bill’s approach is the more defensible one because it reflects the true state of affairs. Jewelry has the greatest sales and so is best able to afford its computed share of the rent cost. As a result, proration reflects the reality and should be relied upon.”
If you were determined to find a peaceful resolution to this conflict, how would you use the concept of proration to move past this conflict?
Attribution: Case study by Morden Shapiro (Ontario Tech University), published under Creative Commons Attribution-NonCommercial-ShareAlike licence (CC-BY-NC-SA)
Any modifications to this case study may affect its solvability and caution is advised.