Ethics and the Manager

Case: Ethics and the Manager

Cristin Madsen is the new divisional controller for the Appliances Division of Solequin Corporation. She has developed the division’s predetermined overhead rate for the upcoming year. Her job is to get the most accurate rate of overhead as possible. “Overhead is an accounting term that refers to all ongoing business expenses not including or related to direct labor, direct materials or third-party expenses that are billed directly to customers. A company must pay overhead on an ongoing basis, regardless of whether a company is doing a high or low volume of business. It is important not just for budgeting purposes but for determining how much a company must charge for its products or services to make a profit.” (Overhead, n.d.)

Ms. Madsen was provided with an estimate of 110,000 direct labor-hours for the coming year by the production manager. To get the predetermined overhead rate, she divided the estimated manufacturing overhead cost by the estimated total units in the allocation base. However, when Ms. Madsen presented the overhead rate, the general manager, Lance Jusic, directed her to shave off 5,000 labor hours. His reason is to have a reserve which will make a boost in the net operating income for their Christmas bonus. The general manager, Mr. Jusic, had an agreement with the previous division controller to shave off the labor hours by 5,000 hours every year.

If $5,000 labor hours are shaved off, the actual overhead will be less than the predetermined overhead rate. The smaller the divisor is the larger the quotient and vice versa, the larger the divisor is the smaller the quotient will be. So this 5% difference will result in an over applied overhead rate. Over applied overhead is the “excess of overhead applied to work-in-process inventory over the amount of overhead actually incurred. This amount (called favorable variance) is added to the budgeted profit in the end-of-accounting-period financial statements.”...