The purpose is to analyse an issue regarding the cost allocation among divisions and how to better allocate the maintenance service cost internally and enhance the efficiency and motivation of their performance.
1.2 The issue
The method provided by Johnson leads issue to the Delta Division because it cannot be implemented in an optimal manner. Additionally, Johnson promised that the Delta Division only needed to pay $10,000 monthly after the conversion of its maintenance service from outsourcing ($15,000). However, the actual payment turned out to be $18,600, the cost difference is more than $8,000 (=$10,000-18,600).
1.3 Alternative Methods
A variety of costing methods is based on ABC system will be applied in order to seek …show more content…
Before the conversion, the Delta Division have paid $15,000 to the external supplier monthly as routine maintenance service payment, while the service department agreed to provide the division with the maintenance service of 200 hours if the Delta Division pays $10000 monthly by the use of the excess capacity. Dan Thompson, the general manager of the Delta Division agreed to accept the offer.
The truth was, however, that one month later the Division was charged internally at the amount of $18,600, and this amount was substantially beyond the budgeted payment of $10,000, which was also $3,600 higher than the payment to the external supplier, that both parties had negotiated before insourcing. At this stage, Thompson requested Johnson to provide a detailed explanation for why this had happened. Subsequently, Johnson provided two tables in which the detailed information about each division was illustrated. In addition, the Maintenance Department has a capacity of 2000 hours
The application is illustrated as …show more content…
It increases the maintenance cost of the Division monthly, and decrease its profit, this is against the intention of converting the service from outsourcing to insourcing.
(3) However, it is understandable that the service department charged $93 per hours in order to maximize the wealth of its division which could result in an increase in their salaries accordingly. While the Delta tends to minimize the cost of its service payment.
(4) For the company itself, the top management team might endeavour to find ways of addressing the problems because if the issue fails to be addressed, the rest divisions might eventually choose to outsource their maintenance service afterwards. This will have a tremendous impact on the performance and efficiency of their employee’s work.
As the variable cost remains at $50 ($10,000/200 hours) constantly. Therefore, the most effective way to release this tension is to seek for alternative methods, which is able to meet the needs by the decrease in the fixed cost.
According to Table 2.1 and 2.2, obviously, the ABC method is slightly better than the single rate method, because it allocates the type of costs. It is easy for managers to know how much they have paid for variable and fixed cost (Horngren et al