Headquarters Overhead Cost Allocation at Korea Auto Insurance Co. Inc. Sample Essay

Sangil Kim. Professor Ho-Young Lee and Professor Won-Wook Choi wrote this instance entirely to supply stuff for category treatment. The writers do non mean to exemplify either effectual or uneffective handling of a managerial state of affairs. The writers may hold disguised certain names and other placing information to protect confidentiality. Ivey Management Services prohibits any signifier of reproduction. storage or transmission without its written permission. Reproduction of this stuff is non covered under mandate by any reproduction rights organisation. To order transcripts or bespeak permission to reproduce stuffs. contact Ivey Publishing. Ivey Management Services. c/o Richard Ivey School of Business. The University of Western Ontario. London. Ontario. Canada. N6A 3K7 ; phone ( 519 ) 661-3208 ; facsimile ( 519 ) 661-3882 ; e-mail [ electronic mail protected ]Copyright © 2009. Ivey Management Services

Version: ( A ) 2009-10-22

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In January 2009. Jin Kim. director of the Taejon City subdivision of Korea Auto Insurance in South Korea. was frustrated. Taejon City had grown quickly since the Korean authorities started traveling cardinal cardinal authorities offices to the metropolis in 2005 and developing big industrial and residential countries around the metropolis. Many private and public research establishments had built research labs in a suburb of Taejon City. Auto insurance companies had opened legion subdivisions to capture new clients. As a consequence. the Taejon City subdivision of Korea Auto Insurance Co. Inc. had experienced terrible competition and made attempts to capture greater market portion in the part.

After fixing the operations study for the old twelvemonth. Kim realized that his branch’s public presentation was non every bit good as expected. chiefly due to the manner cost accounting systems operated within the company. The current cost accounting systems penalized subdivisions that generated more gross during the financial twelvemonth. Korea Auto Insurance Co. Inc. was one of the three largest liability insurance companies in Korea. Selling car insurance policies was its primary service. The company had allocated overhead costs incurred at the central offices across operating subdivisions under a traditional volume-based allotment procedure. Operating expense costs included resources spent by the central offices for information engineering services. general disposal and selling activities.

The job was that the headquarters’ operating expense costs had been allocated to subdivisions harmonizing to the sum of gross each subdivision generated. Differences in the cost construction of each subdivision were non considered in the procedure. As a consequence. some subdivisions were allocated a big part of operating expense. but felt they had non benefitted much from headquarters’ resources. Some subdivision directors had complained about the current allotment procedure of operating expense. They argued that their net incomes marks were improbable to be reached. entirely because of the inappropriate cost allotment procedure the company had applied.

For usage merely in the class Cost Managment at Dalhousie University taught by Jim Power. from Jan 4. 2012 to Apr 5. 2012. Use outside these parametric quantities is a copyright misdemeanor.

Yonsei University


Kim was transferred to the Taejon subdivision in 2008. He was considered a cardinal participant in the Strategic Planning Department at the central office before being transferred to the subdivision. He had been involved in major concern undertakings and gained a repute for his ability to be after and budget. In 2007. he successfully directed a three million dollar undertaking set uping an endeavor resource planning ( ERP ) system for the full company. He was expected to be promoted to an executive officer place finally. Transfering Kim to the Taejon subdivision was a favour from the top direction intended to give him an chance to derive field experiences at the subdivision degree. as was normally expected of future cardinal executive officers.

Taejon was a quickly turning metropolis and a strategically of import topographic point for Korea Auto Insurance Co. Inc. to spread out its market portion. Kim volitionally accepted the place. After he took the subdivision director place. Kim worked difficult to better the operating consequences of the subdivision. Headquarters besides provided the Taejon subdivision with more marketing staff and more office infinite. As a consequence of these attempts. the Taejon subdivision raised insurance grosss from $ 23. 6 million in 2007 to $ 33. 2 million in 2008. However. Kim was frustrated after shuting his books while fixing the subdivision operation study for the financial twelvemonth 2008. He realized that the 2008 net income of the Taejon subdivision was much lower than for the anterior twelvemonth. The additions in operating costs. including overhead costs allocated from the central offices. were much higher than the grosss.

Background: Korean INSURANCE Market

The insurance market of Korea had two features that made it distinct from the markets of other OECD states. First. car insurance was by far the best merchandising policy in the Korean insurance market. Other belongings insurance policies against casualties. such as existent estate insurance against fire. were sold much less. proportionately. in the Korean market than in the United States. The authorities mandated car proprietors to buy liability insurance. Government-driven economic growing had pushed gross national income per capita to $ 20. 000 in the 2000s. Korean car shapers. such as Hyundai and Kia. had made advancement. technologically and financially. and had been able to run into all the increasing demands from Korean car purchasers. Having more autos on the street meant more gross for car insurance companies. Second. the Korean fiscal industry was to a great extent regulated by the authorities.

The Financial Supervisory Service. a authorities organisation that ruled all the fiscal establishments. provided really specific runing guidelines to the market participants. It besides monitored whether the fiscal market was dominated by any chaebols. concern pudding stones owned by households. Heavy ordinance and over-protection of the industry had weakened the competitory border of many fiscal companies. Korea Auto Insurance Co. Inc. was a typical instance. An car insurance company could afford to maintain utilizing a potentially unreasonable method of overhead allotment because its direction lacked runing liberty since the car insurance industry had been tightly regulated by the authorities. Although the authorities had non dictated overhead cost allotment methods. the direction of insurance companies tended to slackly follow the simplest or least controversial methods without paying attending to the managerial effects in item.

For usage merely in the class Cost Managment at Dalhousie University taught by Jim Power. from Jan 4. 2012 to Apr 5. 2012. Use outside these parametric quantities is a copyright misdemeanor.

Taejon City had. in recent old ages. dramatically improved its substructure by constructing new expresswaies and presenting electric railroads and a train a grande vitesse ( TGV ) or high-velocity train. These alterations attracted more people to the metropolis and therefore expanded the market for car insurance. The central office of Korea Auto Insurance Co. Inc. tried to capture the Taejon market in front of possible rivals by supplying assorted supports to the subdivision. These supports included increasing the branch’s selling staff from 27 to 35. Sending Kim to the Taejon subdivision was a top-level direction determination to do the subdivision more competitory. Kim. nevertheless. realized that enlargement of the subdivision might punish him and subdivision employees by non merely incurring direct costs at the subdivision degree but besides by the subdivision being allocated a big sum of the headquarters’ operating expense costs. ensuing in lower net income. HEADQUARTERS’ OVERHEAD COSTS

Exhibit 1 illustrates the cost construction of Korea Auto Insurance Co. Inc. Direct costs accounted for about 60 per cent of entire costs while indirect costs accounted for about 40 per cent of entire costs. Direct costs consisted of both operating costs ( 48 per cent ) and administrative costs ( 12 per cent ) . Exhibit 2 studies headquarters’ overhead costs and their allotment bases. There were five squads in the central offices: information engineering ( IT ) . runing support ( OS ) . investing. selling and general administrative ( GA ) . Costss of the IT squad dramatically increased from $ 18. 4 million in 2007 to $ 24. 3 million in 2008. The primary ground for such an addition was the depreciation disbursal of investing in the ERP system introduced in late 2007.

Depreciation was computed based on the straight-line method over a utile life of five old ages. Ironically. the successful launching of a new IT system in late 2007 by Kim at the central office was a major factor in bettering the operating public presentation of the Taejon subdivision in 2008. The five squads at the central offices were the cost centres for operating expense. They supported the operating activities of the subdivisions and their support was indispensable in keeping the concern substructure of the company. Exhibit 3 lists assorted costs incurred by these squads during the last two old ages. Primary activities of the IT squad included branch PC care. central offices IT system support and employee computing machine preparation. The OS squad provided gross revenues developing. runing public presentation rating. rating coverage. and traffic accident instance managing. Activities and several costs of the investing. selling and GA squads. along with those of the IT and OS squads. are provided in Exhibit 3. Indirect COSTS DISTRIBUTED TO SALES BRANCHES

Kim was frustrated that the current overhead allotment patterns of Korea Auto Insurance Co. Inc. did non take into history the importance of operating expense costs. Until 2006. the differences in overhead sums allocated across subdivisions were non important. However. the differences became important as the sum of operating expense increased and activities became more diversified. Exhibit 4 provides biennial informations for possible cost drivers that could be used as a footing to apportion overhead costs to runing subdivisions including Taejon. Exhibit 5 outlines the Taejon branch’s grosss and direct costs for the last two old ages. Exhibit 5 indicates that the proportion of direct costs over entire grosss decreased from 72 per cent in 2007 to 67. 5 per cent in 2008. reflecting Kim’s attempts. Primary overhead costs incurred by each squad at the central offices are discussed below.

For usage merely in the class Cost Managment at Dalhousie University taught by Jim Power. from Jan 4. 2012 to Apr 5. 2012. Use outside these parametric quantities is a copyright misdemeanor.

IT Team

The costs of IT were associated with activities such as branch PC care. central offices IT system support. subdivision IT system support and employee computing machine preparation. The company presently used subdivision insurance gross as the allotment base of costs incurred by the IT squad. However. operating expenses that were really relative to gross included the costs of back uping the IT systems of central offices and subdivisions. Branch Personal computer care costs were about relative to the figure of Personal computers. Attending a computing machine developing plan was compulsory for all employees and an appropriate cost driver for the computing machine preparation costs would be the figure of employees.

Kim had analyzed and reorganized subdivision activities the old twelvemonth and significantly reduced non-value added activities. As a consequence of this reorganisation. he reduced the figure of employees from 82 in 2007 to 45 in 2008. This reorganisation was a painful procedure ; nevertheless. it grabbed management’s and major shareholders’ attending as an illustration of the firm’s value creative activity and Kim’s repute was bolstered. However. Taejon’s cost decrease attempt was non rewarded with lower operating expense allotment under the current allotment method based on the branch’s gross.

Operating Support Team

Primary maps of the OS squad included running preparation plans for insurance gross revenues forces. managing traffic accident instances. and fixing runing public presentation studies across subdivisions. Training costs were straight related to the figure of gross revenues people in each subdivision. Costss of fixing runing public presentation studies should hold been treated the same manner across subdivisions. Costss of managing traffic accidents were relative to the figure of accidents. However. Korea Auto Insurance Co. Inc. allocated the overhead costs of the OS squad based on gross sums generated by the subdivisions. The cost of managing traffic accident instances was $ 16. 4 million in 2008. This accounted for the largest proportion of entire overhead costs at central offices. Kim regarded the minimisation of these costs every bit critical to his cost-saving attempts. He hence used public dealingss and runs throughout 2008 to forestall clients from being involved in accidents. He besides tried to minimise the figure of bad clients handled by his subdivision through de-marketing. As a consequence of his attempts. the figure of accidents in the Taejon subdivision decreased from 54 instances in 2007 to 31 in 2008. Regardless. the sum of operating expense costs allocated from the central offices increased in 2008.

Investing Team

The investing squad was in charge of the investing of hard currency generated from insurance premiums. Costss of investing in equity or debt securities were associated with the sum of investing. This sum was by and large relative to the sum of insurance gross generated. Costss of investing public presentation rating and coverage did non vary much across subdivisions. The activities of the investing squad were non straight related to activities conducted in the subdivisions. By concentrating on bring forthing investing additions. the activities of the investing squad were independent of subdivision runing activities. Marketing Team

The selling squad advertised and developed new merchandises and channels. Ad costs included money spent for Television commercials. Internet streamers and other public dealingss activities to present

For usage merely in the class Cost Managment at Dalhousie University taught by Jim Power. from Jan 4. 2012 to Apr 5. 2012. Use outside these parametric quantities is a copyright misdemeanor.

The allotment base of advertizement costs was presently branch gross. Kim believed. nevertheless. that there was small causal relationship between countrywide advertizement and subdivision public presentation in footings of grosss. Kim reasoned that advertizements could ensue in branchspecific gross additions. but did non profit Taejon more than other subdivisions. New merchandise and channel development costs were necessary to supply operating substructure for subdivisions. Kim believed that these costs might non be related to the incremental grosss of subdivisions. General Administrative Team

The GA squad was in charge of keeping the company’s assets and human resources. Costss incurred by the GA squad were specifically related to payroll. forces rating and employee preparation. Care costs of the central offices edifice were allocated to the Taejon subdivision on the footing of gross. although the costs were non related to the operating activities of the subdivisions. Kim believed that the figure of employees would be a more appropriate allotment base for costs incurred by the GA squad. He felt that the current allotment method was non just since he tried to salvage GA costs by cut downing the figure of employees in 2008 and was non rewarded under the current method. Decision

Kim believed that the current cost allotment method was non appropriate. The current overhead allotment system resulted in inefficient resource allotment and provided subdivision employees with inappropriate inducements that might take down steadfast value in the long tally. Kim. therefore. prepared a more relevant and accurate runing study based on an alternate overhead allotment method that used more appropriate cost drivers than current gross sums.

Kim put a letter-size notepad on his desk and thought about the best manner to carry direction to utilize more appropriate cost allotment systems. He believed that one manner to carry direction was to supply a numerical illustration that demonstrated how it was possible to make misdirecting decisions based on information generated by the current cost allotment systems. Kim realized that. while most overhead costs should be allocated to runing subdivisions. certain central office costs did non hold to be allocated at all to subdivisions unless there was a direct proportional relationship between these resources and subdivision activities. He gathered relevant information for developing a better cost allotment system.

For usage merely in the class Cost Managment at Dalhousie University taught by Jim Power. from Jan 4. 2012 to Apr 5. 2012. Use outside these parametric quantities is a copyright misdemeanor.