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One reason the Pennsylvania Railroad went broke

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[quote user="greyhounds"]   <blockquote> <div><img src="/TRCCS/Themes/trc/images/icon-quote.gif" /> schlimm:</div> <div>   Thanks for the explanation.  I am no cost accountant, but I seem to recall that fixed costs (overhead) have to be allocated to the price of goods or services in some way or else a company loses money if it only covers the variable costs.  Fully allocated costing is one such method, which I do recall is often disliked by the sales departments and can create some internal tension with the accounting department of a company. <div style="clear:both;"></div>   </div> </blockquote>   No, fixed costs (overhead) doesn't have to be allocated.  It has to be covered, but it can't rationally be allocated in diverse output enterprises such as a railroad (Or a McDonalds).   People can, and have, come up with formulas for such allocations.  But just because there is a formula that produces a number doesn't mean the number is meaningful.   Again, in railroading and other lines of trade, overhead cost has to be covered but it can't be rationally allocated to specific units of sale. Pricing is much more complex than crunching a bunch of numbers.    In the subject situation the railroads involved couldn't set the price.  The price was being set by competition.  In this case a truck-barge movement of ingots.   The maximum rail price that would get the business was above the rail variable cost but below the contrived fully allocated rail cost.     So should the railroads want business at a maximum price that is above variable but below fully allocated cost? Of course they would want such business.  They would be better off with the business as it would make some contribution to covering their fixed costs.  When the government regulators rulled that they could not price at such a level they seriously hurt the Pennsylvania Railroad and other railroads.   Not only did such a rulling hurt the railroads, it hurt the nation because it prevented the US from receiving maximum benefit from its railroads. In 1967 the Pennsylvania Railroad had precious little traffic that was not subject to truck and/or barge competition.  When the dang government greatly restricted their ability to compete for such business, it was, by in large, a death sentance for the railroad.   (See "In the Matter of Container Service" for another inane government decision that helped kill the Pennsy.) Again, can you explain why the government needed to even be involved in this situation, or any other such situation where the pervasive intermodal competition existed.   They only screwed things up and hurt the country. [/quote] Allocation of overheads and fixed costs to product lines is a complex subject.  It is beyond the scope of these forums.  Having said that, a business can determine the cost of goods sold, which includes an allocation of overheads, to determine its operating profit, and then look to cover the fixed costs with the combined product operating profits.   In the case of the electric utility business in Texas, upon deregulation, we determined that we needed to allocate some of the fixed costs, i.e. depreciation, interest, taxes, etc. by product line and by segments, e.g. generation, transmission, distribution, retail, etc.  Actually, the regulator required us to do it.  We were able to come up with fixed cost allocation models that were acceptable to management, the regulators, and perhaps most importantly our external auditors.   Allocations contain heaps of estimates.  The key question is whether they are logical and can be supported.
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