Question

BTN 15-3 An accounting professional requires at least two skill sets. The first is to be technically competent. Knowing how to capture, manage, and report information is a necessary skill. Second, the ability to assess manager and employee actions and biases for accounting analysis is another skill. For instance, knowing how a person is compensated helps anticipate information biases. Draw on these skills and write a half-page memo to the financial officer on the following practice of allocating overhead.

Background: Assume that your company sells portable housing to both general contractors and the government. It sells jobs to contractors on a bid basis. A contractor asks for three bids from different manufacturers. The combination of low bid and high quality wins the job. However, jobs sold to the government are bid on a cost-plus basis. This means price is determined by adding all costs plus a profit based on cost at a specified percent, such as 10%. You observe that the amount of overhead allocated to government jobs is higher than that allocated to contract jobs. These allocations concern you and motivate your memo.

Point: Students could compare responses and discuss differences in concerns with allocating overhead.

Answer 1

This memo is in reference with the different costing principles being followed in the allocation of overhead and costing of the government and general contracts. While there is no wrong in following cost plus basis to determine the price for the government contract, there seems to be a major variation in how overheads are allocated. Since we follow traditional method of cost allocation, I have observed that there is a major variation in the overhead allocation which puts extra pressure on our profil margins and what we quote. Wrong costing and consequently wrong pricing can have unreversing effects like loss of market share, non-renewal of contracts because of lower price of competetitors among others. As a Management Accountant, I suggest you to review the overhead allocation sheet attached with this memo. I would also advise to switch to ABC method of overhead allocation.

Regards