You have recently been hired as an accountant for the largest residential constr

Question

You have recently been hired as an accountant for the largest residential construction company in the state. Your primary responsibility is to track costs for each home being constructed. Tracking the costs for direct material and direct labor is relatively straightforward. Each home under construction has a job cost sheet. Materials requisitioned for each home site are carefully tracked and the construction workers are very careful about assigning their time to the homes they work on.

Accounting for manufacturing overhead costs, on the other hand, presents quite a problem. In the past, overhead has been allocated on the basis of direct labor hours. As a result, since larger houses require more workers, those houses have been allocated a larger share of the overhead.

Your company was recently selected by the state to build a number of low-income housing complexes. The state has agreed to an arrangement whereby they will pay your costs plus a 10 percent profit. Construction of these low-income housing units will be relatively simple and will not require a great deal of materials or labor, compared to the average house the company builds.

At a meeting following the granting by the state of the construction contract, the production foreman proposes the following idea: “Since the state has agreed to pay our costs plus 10 percent, the higher the costs on the project, the more money we make. What we need to do is to funnel as much of our costs as possible to this low-income housing project. Now I don’t want anyone to think I am proposing something unethical. I am not saying that we should charge the state for fictitious costs. What I am saying is that we should allocate as much overhead as possible to the low-income project. Therefore, I propose that we allocate overhead on a per-house basis with each house, regardless of size, being allocated the same amount of overhead.”

You have analyzed the activities that drive overhead costs and have found that bigger houses, in addition to requiring more direct materials and direct labor, require more inspections, more supervisions, etc. You can see that most in attendance at the meeting are being persuaded by the production foreman’s idea. You slowly raise your hand. It takes about ten seconds before al the voices go quiet. You look around the table and see ten of your colleagues staring at you. You open your mouth and…

Questions

1. What would you do in this situation? Is the overhead allocation method being proposed by the production foreman illegal? Is it unethical? Is it good strategy?

2. Suppose you argue that overhead should continue to be allocated on the basis of direct labor hours. After hearing your points, the group votes to go with the production foreman and allocate the overhead on a per-house basis. What would you do next?

3. Now, go back to your responses above and think carefully about what might be wrong with your logic or your approach. What are the potential risks or problems in your answers?

Explanation / Answer

1. What would you do in this situation? Is the overhead allocation method being proposed by the production foreman illegal? Is it unethical? Is it good strategy?

The situation is an ideal situation for any organization because the state has agreed to pay all the cost of construction and also a profit margin of 10 percent to tithe organization. As this a low-income housing project the budget is low compared to other projects and as we are already getting a profit of 10 percent I will oppose the proposal forwarded by the foreman because if the cost of construction is raised the apartments need to be sold at a high price which will actually affect the low income group.

No, the overhead allocation method proposed by the foreman is not illegal, rather organizations follow such practices in order to make more profit.

Yes, It is unethical because it is for low-income group so it is better if we maintain a low cost.

I do not think that the strategy is good because as this is a state project we need to be careful because if we do it at a low cost we may get better projects in the future but if the cost is very high in this project then the state may look for other options.

2. Suppose you argue that overhead should continue to be allocated on the basis of direct labor hours. After hearing your points, the group votes to go with the production foreman and allocate the overhead on a per-house basis. What would you do next?

There is a very high chance that this may be the actual situation and in that case I would like to propose my idea to the next level because I believe that my approach will actually benefit the business in the long run but the foreman's idea will benefit the organization now but may lose potential business in the near future, therefore I will let the management decide on this and will act accordingly.

3. Now, go back to your responses above and think carefully about what might be wrong with your logic or your approach. What are the potential risks or problems in your answers?

The potential risk is very much clear because if the state does not give expected business to the organization then there is no business profit but still the ethical aspect of the business will be maintained. Opposing the foreman may influence a negative aspect of mine that may lead to consequences and the members may also oppose my idea and approach. As the idea is not illegal it can be adopted but it may violate ethical norms, therefore the management needs to understand the process and then decide.

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