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[solution]: (1) Do you believe that the solution proposed by Doug is ethical?

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  1. (1) Do you believe that the solution proposed by Doug is ethical? Explain.
  2. (2) Suppose that Tonya decides that Doug?s solution is not right and objects strongly. Further suppose that, despite Tonya?s objections, Doug insists strongly on implementing the action. What should Tonya do?

Case 4-60


Assigning Overhead to Jobs?Ethical Issues


LO 2 LO 5


Tonya Martin, CMA and controller of the Parts Division of Gunderson Pty Ltd, was meeting


with Doug Adams, manager of the division. The topic of discussion was the assignment of


overhead costs to jobs and their impact on the division's pricing decisions. Their


conversation is reproduced below.





TONYA: Doug, as you know, about 25% of our business is based on


government contracts, with the other 75% based on jobs from private sources won


through bidding. During the last several years, our private business has declined. We


have been losing more bids than usual. After some careful investigation, I have


concluded that we are overpricing some jobs because of improper assignment of


overhead costs. Some jobs are also being underpriced. Unfortunately, the jobs being


overpriced are coming from our higher-volume, labour-intensive products, so we are


losing business.






DOUG: I think I understand. Jobs associated with our high-volume products


are being assigned more overhead than they should be receiving. Then when we add


our standard 40% markup, we end up with a higher price than our competitors, who


assign costs more accurately.






TONYA: Exactly. We have two production departments, one labour-intensive


and the other machine-intensive. The labour-intensive department generates much


less overhead than the machine-intensive department. Furthermore, virtually all of


our high-volume jobs are labourintensive. We have been using a plant-wide rate


based on direct labour hours to assign overhead to all jobs. As a result, the highvolume, labour-intensive jobs receive a greater share of the machine-intensive


department's overhead than they deserve. This problem can be greatly alleviated by


switching to departmental overhead rates. For example, an average high-volume job


would be assigned $100 000 of overhead using a plant-wide rate and only $70 000


using departmental rates. The change would lower our bidding price on high-volume


jobs by an average of $42 000 per job. By increasing the accuracy of our product


costing, we can make better pricing decisions and win back much of our privatesector business.






DOUG: Sounds good. When can you implement the change in overhead rates?






TONYA: It won't take long. I can have the new system working within four to


six weeks?certainly by the start of the new financial year.






DOUG: Hold it. I just thought of a possible complication. As I recall, most of


our government contract work is done in the labour-intensive department. This new


overhead assignment scheme will push down the cost on the government jobs, and


we will lose revenues. They pay us full cost plus our standard markup. This business


is not threatened by our current costing procedures, but we can't switch our rates for


only the private business. Government auditors would question the lack of


consistency in our costing procedures.






TONYA: You do have a point. I thought of that issue, too. According to my


estimates, we will gain more revenues from the private sector than we will lose from


our government contracts. Besides, the costs of our government jobs are distorted. In


effect, we are overcharging the government.






DOUG: They don't know that, and never would, unless we switch our


overhead assignment procedures. I think I have the solution. Officially, let's keep our


plant-wide overhead rate. All of the official records will reflect this overhead costing


approach for both our private and government business. Unofficially, I want you to


develop a separate set of books that can be used to generate the information we need


to prepare competitive bids for our private-sector business.





2. Do you believe that the solution proposed by Doug is ethical? Explain.


3. Suppose that Tonya decides that Doug's solution is not right and objects strongly.


Further suppose that, despite Tonya's objections, Doug insists strongly on


implementing the action. What should Tonya do?




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