US MacDonald Corporation
Response to the following problem:
You work for US MacDonald Corporation (USMC), an airplane manufacturer. USMC makes airplanes for commercial airlines, such as United, American, and Delta, and for the U.S. Air Force. Many parts are common to all planes made by USMC. The market for commercial planes is extremely competitive with General Dynamics, Lockheed, and European manufacturer Airbus often bidding lower than USMC. However, USMC's contract with the Air Force allows it to bill them at cost plus a 9% profit
Times have been tough lately for USMC. In fact, if you can't find a way to increase profits, the company may have to lay off 5,000 employees.
A colleague has just presented you with an idea that he believes will increase profits. He suggests that instead of using direct labor hours to allocate overhead costs among airplanes, you should allocate costs on the basis of the number of each type of airplane made. Because you make far more, smaller, less expensive planes for the Air Force, more of the overhead costs will be allocated to those planes. This action will not only decrease your cost per unit on commercial planes (allowing you to be competitive in that market), but will also increase your profits on Air Force planes because the cost per plane will be higher
You are not sure about your colleague's suggested action. You do know that your allocation base of direct labor hours is quite arbitrary and probably does not correspond well to the way overhead costs are consumed.
1. What is an appropriate allocation basis? Would adopting the suggestion be ethical?
2. Would you change your mind if you learned that competitors were allocating overhead on the basis of number of each type of plane made?
3. Is your action appropriate, from both a business and an ethical point of view, if direct labor hours is not an accurate allocation base?