Question

Assume that your company sells portable housing to both general contractors and the government. It sells jobs to contractors on a bid basis. A contractor asks for three bids from different manufacturers. The combination of low bid and high quality wins the job. However, jobs sold to the government are bid on a cost-plus basis. This means the price is determined by adding all costs plus a profit based on cost at a specified percent, such as 10%. You observe that the amount of overhead applied to government jobs is higher than that applied to contract jobs. These allocations concern you.

Required

Write a half-page memo to your company’s chief financial officer outlining your concerns with overhead allocation.

Short answer

The higher overhead allocation leads to an increase in the budget of the business entity. Also, charging higher overhead to the government contract is an unethical activity.

Step-by-step solution

Definition of Overhead

Overhead can be defined as the expenses incurred by the business entity for operating activities other than the direct costs incurred in the production process.

Memorandum to Chief Financial Officer

Date: XX/XX/XX

To: Chief financial officer

From: Accountant

Subject: Concern regarding the overhead allocation

The overall allocation is too much higher, which has increased the budget of the business entity. The business entity must allocate these overheads based on the overhead rate to get more accurate results.

Another issue is the ethical issue: It is mentioned that government contracts are allocated at a higher cost, which will be considered technically defrauding the government. Therefore, it is also an unethical activity.