- (1) Do you believe that the solution proposed by Doug is ethical? Explain.
- (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?
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
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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