Assume you recently accepted a job with a company that designs and builds helicopters for commercial and military use. The company has numerous contracts with the U.S. military that require the use of cost-plus pricing. In other words, the contracted price for each helicopter is calculated at a certain percentage (about 130 percent) of the total cost to produce it. Unlike the cost-plus pricing approach used for military contracts, the prices for civilian helicopters are based on the amount that individuals and corporations are willing to pay for a state-of-the-art helicopter. As your first assignment, the company controller has asked you to reevaluate the costing system currently used to determine the cost of producing helicopters. The company assigns manufacturing overhead based on the number of units produced. The result is that every helicopter is assigned the same amount of overhead regardless of whether it is for military or civilian use. As part of your assignment, you collected the following information about several other potential allocation bases and how they differ for the two types of customers the company serves:

When you presented these data to the controller, you recommended that the company move to an ABC system that incorporates both volume-based and non volume-based cost drivers. He responded that he wanted you to choose the system that would assign the highest percentage of the total overhead cost to the military contracts. His reasoning was that the cost-plus agreement with the U.S. government would result in a higher contract price for military helicopters without affecting the price of civilian helicopters, which are set by the market.

Required:

1. Explain how changing to an ABC system would impact the profitability of the two types of products.

2. Which costing method do you think the company should use to apply manufacturing overhead to the two types of products? Defend your answer.

3. Identify the ethical issues involved in this scenario. What are your potential courses of action for responding to the controller’s request? What are the potential personal, professional, and legal implications of the alternative courses of action you considered? How would you ultimately respond to this situation?