LABU ACCT case drafttt
KAI uses an inappropriate volume- based cost allocation method that causes inefficient resource allocation, disincentive among employees and weaker financial performance. To improve the existing method, Senior Management should consider reviewing the current situation to identify the problems, followed by adopting an alternative cost allocation method.
The current revenue-based cost allocation method causes inefficient resource allocation, resulting in excess overhead costs. It lacks consideration of each branch’s difference in cost structure and the irrelevant relationship between costs and revenues. The actual needs of different teams are not addressed. For example, the Operating Support Team’s traffic accident handling costs are not related to revenue. Instead, the number of accidents should be used as cost driver. Although the number of accidents decreased by approximately 43% from 54 cases in 2007 to 31 cases in 2008, the traffic accident handling costs increased by approximately 40% from $11.7 to $16.4 million. Apart from inappropriate cost drivers, the method allocated unnecessary resource to branch activities that are not related to operation. For example, the headquarters building’s maintenance costs are not related to Taejon branch’s operating activities; it should not be allocated to the General Administrative Team. The same applies to the Investment Team since its activities are independent of branch’s operation. Use of revenues as the only cost allocation basis leads to excess overhead costs, which lowers the net income of branches.
Allocation of excess overhead costs provides disincentives among employees. Their effort paid on reducing costs is not rewarded with lower overhead costs and their earning targets are harder to be reached. From 2007 to 2008, Taejon branch’s total revenues increased by approximately 40% from $23.6 million to $33.2 million and its proportion of direct costs over total revenues decreased from 72% to 67.5%. These reflect
The current revenue-based cost allocation method causes inefficient resource allocation, resulting in excess overhead costs. It lacks consideration of each branch’s difference in cost structure and the irrelevant relationship between costs and revenues. The actual needs of different teams are not addressed. For example, the Operating Support Team’s traffic accident handling costs are not related to revenue. Instead, the number of accidents should be used as cost driver. Although the number of accidents decreased by approximately 43% from 54 cases in 2007 to 31 cases in 2008, the traffic accident handling costs increased by approximately 40% from $11.7 to $16.4 million. Apart from inappropriate cost drivers, the method allocated unnecessary resource to branch activities that are not related to operation. For example, the headquarters building’s maintenance costs are not related to Taejon branch’s operating activities; it should not be allocated to the General Administrative Team. The same applies to the Investment Team since its activities are independent of branch’s operation. Use of revenues as the only cost allocation basis leads to excess overhead costs, which lowers the net income of branches.
Allocation of excess overhead costs provides disincentives among employees. Their effort paid on reducing costs is not rewarded with lower overhead costs and their earning targets are harder to be reached. From 2007 to 2008, Taejon branch’s total revenues increased by approximately 40% from $23.6 million to $33.2 million and its proportion of direct costs over total revenues decreased from 72% to 67.5%. These reflect