You work for US MacDonald Inc., which makes airplanes for commercial airlines, like United, American, and Delta, and for the U.S. Air Force. Many parts are common to all planes made by MacDonald. The market for commercial planes is extremely competitive with General Dynamics, Lockheed, and European manufacturer Airbus often bidding lower than MacDonald. However, MacDonald’s contract with the Air Force allows it to bill them at cost plus a 9% profit.
Times have been tough lately for MacDonald and 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 a new manufacturing overhead allocation system that will result in more costs being allocated to planes for the Air Force. This action will not only decrease your cost per unit on commercial planes (allowing you to be more 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 to Air Force planes using a similar cost allocation method?
3. Is your action appropriate, from both a business and an ethical point of view, if the current overhead cost allocation system is not an accurate basis?