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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.

 

o

 


 

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.

 


 

o

 


 

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.

 


 

o

 


 

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.

 


 

o

 


 

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

 


 

o

 


 

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.

 


 

o

 


 

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.

 


 

o

 


 

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.

 


 

o

 


 

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.

 


 

Required:

 

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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