Question

Susan Tanks, manager of a division that produces air-to-ground radio communication units on a special-order basis, was excited about an order received from a nearby military base for 10,000 radio units. The military agreed to pay full manufacturing cost plus 25 percent. The order was timely since business was sluggish, and Susan had some concerns about her division’s ability to meet its targeted profits. Even with the order, the division would likely fall short in meeting the target by around $50,000. After examining the cost summary for the order, however, Susan thought she saw a way to increase the profitability of the job. Accordingly, she called Larry Flyright, the controller of the division.

Susan: “Larry, the cost summary you gave me for the new military order reflects an allocation of maintenance costs to the Assembly Department based on maintenance hours used. Currently, 60% of our maintenance costs are allocated to Assembly on that basis. Can you tell me what the allocation ratio would be if we used machine hours instead of maintenance hours?”

Larry: “Sure. Based on machine hours, the allocation ratio would increase from 60% to 80%.”

Susan: “Excellent. Now, tell me what would happen to the unit cost of the military job if we used machine hours to allocate maintenance costs.”

Larry: “Hold on. That’ll take a few minutes to calculate. … The cost would increase by $10 per unit.”

Susan: “And with the 25% markup, the revenues on that job would jump by $12.50 per unit. That would increase profitability of the division by $125,000. Larry, I want you to change the allocation base from maintenance hours worked to machine hours.”

Larry: “Are you sure? After all, if you recall, we spent some time assessing the causal relationships, and we found that maintenance hours reflect the consumption of maintenance cost much better than machine hours. I’m not sure that would be a fair cost assignment. We’ve used maintenance hours as the allocation base for years now.”

Susan: “Listen, Larry, allocations are arbitrary anyway. It’s not like there’s a rule that says we have to use maintenance hours as an allocation base. Changing the allocation base for this military order will increase its profitability and allow us to meet our targeted profit goals for the year. If we meet or beat those goals, we’ll be more likely to get the capital we need to acquire some new equipment. Furthermore, by beating the targeted profit, we’ll get our share of the bonus pool. Besides, the U.S. military can easily afford to pay somewhat more for this order.”

After some thought, Larry decided that he couldn’t comply with Susan’s request to change the allocation scheme. Appeals to higher-level managers within the company were in vain. Everyone seemed to agree with Susan that her request represented good business sense and that Larry should do as Susan had requested. Angered, Larry submitted his resignation and called the military department that had placed the special radio unit order. In his phone conversation, Larry revealed Susan’s plan to increase the job’s costs in order to improve her division’s profits. The military officer in charge of the purchase expressed his gratitude to Larry and promptly canceled the order for 10,000 radio units.

Required – Follow the Ethics Assignment Guidelines and prepare an essay that addresses the following:

Identify the dilemma(s). What exactly is the decision(s) that must be made?

(In your answer, please feel free to show your knowledge of management accounting and/or what you have learned this semester!)

Identify the primary stakeholders and consider their viewpoints. Who has a stake in the decision?

What additional alternatives did Larry have other than resigning? Analyze the alternatives and consequences. Clarify the main alternatives available to Larry and predict how each alternative would affect the primary stakeholders.   If appropriate, address Susan’s reasoning.

Defend the position and action(s) you would have taken. Be clear. Tell why your course of action would be better than that chosen by Larry. Show your knowledge of what we have learned thus far in the course.

Answer 1

There are two dilemmas-

1. Manupulaing the allocation base to achieve profitability targets
2. Calling the customer and revealing them about the plan to increase the job’s costs in order to improve division’s profits.

The decisions should be as follows-

1. The allocation base shouldn't be manupulated by changing the allocation scheme.
2. The customer shouldn't be informed about planning and decisions of the organisation.

Cost allocation is a process to find cost of different cost object. Through this cost of a product or a service is calculated. It is important to allocate the cost appropriately otherwise it will reflect wrong price.

An employee disclosing inside information to others including the customers is against employees code of ethics. Being an employee or ex-employee of an organisation, he should follow the code and shouldn't disclose organisations internal planning and decisions.

Primary Stakeholders are those people who are directly affected by business activities. It includes customers, employees, suppliers, creditors, stockholders, or anyohter person with financial interest in product or situation.

The customer is concerned with value and quality of the product. From his point, the pricing of an product should be done ethically.
And
The Employee is concerned with job security, compensation, truthful communication. For good compensation and recognition, an employee may manupulate cost allocation to show high profitability of an product but it miscommunicate with othe sake holders. So, from his point of view also, the allcation of cost and pricing of an product should be done appropriately.

The stokeholders are the real owner and investor of the company. They are concerned with profitability, longivity and growth. An misallocation of cost which shows wrong profitability could harm the organisations as it misleads it. So, From there point of view, the allocation should be done appropriately.

In this given case, the management should prioritize the stake of stokeholders and Customers. They has the stake in the decision because the given case is directly connected with their stake.

Larry have the following alternatives-

1. Accept susan's suggestion as it is accepted by the higher management as well. As a consequence there will be change in allocation base from maintenance hours to machine hours.
2. Take this issue to the board to directors. The decision of directors would be final.
3. Explain and convince the management about the outcomes of inappropriate allocations of costs. As a result, there won't be any ethical dilemmas.

In the 1st case, it would effect stakes of customers more and also effect the stokeholders because it will reflect wrong profitabily and the company would spend its resources in wrong product.

in 2nd alternative, Borad will take decision in favor of stockholers interest but if they agrees with susan, this may effect stake of customers.

the best alternative is 3rd one, with takes care of stake of all stakeholders. Becase it takes care of financial interest of customer as well as interest of stock holders. This also elemates ethical dilemmas of employees as well.

The mechanism of allocation involves identifying most appropriate basis for allocationg costs. Allocations aren't arbitrary. For correct pricing and determing product profitability, it is important to allocate costs appropriately. Otherwise, the company would lost its resources it a loss making product and sustainibilty of the concern would be in denger.
So, in give case, susan's reasoning is not appropriate.