Employees' Incentives to Mis-state Product Costs
Chris Maynard, one of Owens Metal Products' three customer engineers, is reviewing the costs of the radar housings for Lingle Aerospace (LA). LA is one of Maynard's largest accounts and the radar housing is a fabricated piece of sheet metal LA uses to assemble an aircraft's radar system installed in the nose of the plane. In reviewing the detailed cost record for this job, Maynard is concerned that the direct labor posted to the job appears too high. He estimated the direct labor in the welding department to be six hours per batch of 130 units. But the job sheet reports that 9.5 hours were used.
Background
Owens Metal Products is a custom machine shop that bids on orders and produces sheet metal parts in batches. It was founded 30 years ago by two tool and die makers in their mid-30s: Jack Spence and Don Carter. Spence and Carter were previously employed by a national automobile company. They started Owens to make parts for local large manufacturing firms that did not have sufficient capacity to meet short-run production schedules. Now Owens competes by supplying certain types of parts more cheaply than large companies can produce them internally. It does this by (1) bidding on jobs with run lengths that match Owens's machine configurations, (2) employing nonunion labor, and (3) avoiding much of the overhead existing in big factories. Owens Metal Products now manufactures sheet metal parts used in a variety of office products, computers, and printers. The firm has grown in recent years and has benefited from the outsourcing movement whereby large firms seeking to reduce their manufacturing costs outsource noncritical metal fabricated parts.
Owens's single plant has a number of sheet metal presses (the largest being a 500-ton press), numerically controlled cutting and drilling machines, lathes, drill presses, and electric arc welders. Engineers contact customers to see if they have parts they are willing to outsource. Usually, the customer is introducing a new model and has not produced the tools necessary to fabricate the part internally. Owens's customer engineer works with the client on the manufacturing and design specifications for the part and submits a bid to produce and deliver a set number of parts over a given time period at a fixed price. In the process of preparing the bid, the customer engineer forecasts the cost of the job by estimating direct labor, direct material, and machine time required in each factory department.
Due to intense competition from other firms (as large office equipment companies constantly shift production worldwide to find the lowest-cost, highest-quality producers), shops such as Owens have high variability in volumes. In response to these volume changes, Owens is always laying off and rehiring employees. If Owens loses a large contract, it often requires six to nine months to replace the work. In the meantime, employees are laid off until new work can be found.
Two hundred employees now work at Owens, including sales, administrative, and factory employees. Besides production workers, Owens has a maintenance and janitorial staff. To improve cost competitiveness, Spence and Carter have been trying to get production employees to take over more of the maintenance and clean-up tasks when they have idle time. They would also like to see the workers cross-trained in more production and maintenance tasks to help better balance work flow in the factory. These actions will raise productivity and reduce costs. However, the attempts at cross-training have achieved very limited success.
Compensationsystem
Owens does not have a formal pay-for-performance or bonus system. All employees are paid straight salary with annual raises. Customer engineers do not receive commissions for sales. In good years, raises are higher. Management has explored incentive pay and piece-rate systems. They have concluded that the constantly changing product mix would cause such systems to be very expensive to implement and maintain.
At a sales staff meeting in February, Phil Matson, Owens's vice president of operation, mentioned they were going to award bonuses to the customer engineers if they could achieve their target sales forecasts. In July, Chris Maynard, whose sales were up 22 percent over the previous year, asked Matson whether total sales were ahead of the target needed for the bonus. Matson said that while sales were up for the year, the plant still had excess capacity and it appeared they would not achieve the forecast.
Accountingsystem
A job order cost system is used to accumulate direct labor and direct materials to individual jobs. At the end of the day, employees fill out a time sheet indicating the jobs they worked on and the time spent on each job. All the indirect costs are accumulated into a separate overhead cost pool for each factory department (pressing, drilling, and welding). The indirect costs for each department include equipment depreciation and lease charges, the department supervisor's salary, employees' idle time, and allocated utilities and occupancy charges (property taxes, plant building depreciation). Then, separate overhead rates are set for each department using direct labor hours as the allocation base. When an employee posts time to a particular job, the overhead rate for the employee's department multiplied by the employee's time charged to the job is the amount of overhead for that department charged to the job.
ProblemwiththeLingleAerospacejob
Chris Maynard contacts Phil Sanchez, supervisor of the welding department, and asks about the discrepancy between Maynard's estimate of 6.0 hours in the welding department and the 9.5 hours actually charged to the LA contract. Sanchez admits that there were two other jobs in the welding department at that time and that it is possible the employee had mistakenly charged some time to the LA contract instead of the other jobs.
Maynard then asks Linda Rawlings, supervisor of the drilling department, about the 67 labor hours charged to LA. Maynard had estimated the drilling time to be 53 hours for the batch. Rawlings said she was too busy now to look into the matter but she would contact him later. That was two weeks ago. Maynard is concerned that if the costs charged to the LA contract are too high, Phil Matson will ask LA for a higher price. If this happens, LA might shift the radar housing from Owens to another supplier.
When Jack Spence learned of the accounting errors on the LA account, he replied, "I don't see any problem. As long as the time cards are charged to jobs, our tax returns are right."
Required:
a. Identify various problems at Owens.
b. What improvements would you suggest Owens implement?

Question

Quizplus · Accepted Answer

The Answer of Employees' Incentives to Mis-state Product Costs
Chris Maynard, one of Owens Metal Products' three customer engineers, is reviewing the costs of the radar housings for Lingle Aerospace (LA). LA is one of Maynard's largest accounts and the radar housing is a fabricated piece of sheet metal LA uses to assemble an aircraft's radar system installed in the nose of the plane. In reviewing the detailed cost record for this job, Maynard is concerned that the direct labor posted to the job appears too high. He estimated the direct labor in the welding department to be six hours per batch of 130 units. But the job sheet reports that 9.5 hours were used.
Background
Owens Metal Products is a custom machine shop that bids on orders and produces sheet metal parts in batches. It was founded 30 years ago by two tool and die makers in their mid-30s: Jack Spence and Don Carter. Spence and Carter were previously employed by a national automobile company. They started Owens to make parts for local large manufacturing firms that did not have sufficient capacity to meet short-run production schedules. Now Owens competes by supplying certain types of parts more cheaply than large companies can produce them internally. It does this by (1) bidding on jobs with run lengths that match Owens's machine configurations, (2) employing nonunion labor, and (3) avoiding much of the overhead existing in big factories. Owens Metal Products now manufactures sheet metal parts used in a variety of office products, computers, and printers. The firm has grown in recent years and has benefited from the outsourcing movement whereby large firms seeking to reduce their manufacturing costs outsource noncritical metal fabricated parts.
Owens's single plant has a number of sheet metal presses (the largest being a 500-ton press), numerically controlled cutting and drilling machines, lathes, drill presses, and electric arc welders. Engineers contact customers to see if they have parts they are willing to outsource. Usually, the customer is introducing a new model and has not produced the tools necessary to fabricate the part internally. Owens's customer engineer works with the client on the manufacturing and design specifications for the part and submits a bid to produce and deliver a set number of parts over a given time period at a fixed price. In the process of preparing the bid, the customer engineer forecasts the cost of the job by estimating direct labor, direct material, and machine time required in each factory department.
Due to intense competition from other firms (as large office equipment companies constantly shift production worldwide to find the lowest-cost, highest-quality producers), shops such as Owens have high variability in volumes. In response to these volume changes, Owens is always laying off and rehiring employees. If Owens loses a large contract, it often requires six to nine months to replace the work. In the meantime, employees are laid off until new work can be found.
Two hundred employees now work at Owens, including sales, administrative, and factory employees. Besides production workers, Owens has a maintenance and janitorial staff. To improve cost competitiveness, Spence and Carter have been trying to get production employees to take over more of the maintenance and clean-up tasks when they have idle time. They would also like to see the workers cross-trained in more production and maintenance tasks to help better balance work flow in the factory. These actions will raise productivity and reduce costs. However, the attempts at cross-training have achieved very limited success.
Compensationsystem
Owens does not have a formal pay-for-performance or bonus system. All employees are paid straight salary with annual raises. Customer engineers do not receive commissions for sales. In good years, raises are higher. Management has explored incentive pay and piece-rate systems. They have concluded that the constantly changing product mix would cause such systems to be very expensive to implement and maintain.
At a sales staff meeting in February, Phil Matson, Owens's vice president of operation, mentioned they were going to award bonuses to the customer engineers if they could achieve their target sales forecasts. In July, Chris Maynard, whose sales were up 22 percent over the previous year, asked Matson whether total sales were ahead of the target needed for the bonus. Matson said that while sales were up for the year, the plant still had excess capacity and it appeared they would not achieve the forecast.
Accountingsystem
A job order cost system is used to accumulate direct labor and direct materials to individual jobs. At the end of the day, employees fill out a time sheet indicating the jobs they worked on and the time spent on each job. All the indirect costs are accumulated into a separate overhead cost pool for each factory department (pressing, drilling, and welding). The indirect costs for each department include equipment depreciation and lease charges, the department supervisor's salary, employees' idle time, and allocated utilities and occupancy charges (property taxes, plant building depreciation). Then, separate overhead rates are set for each department using direct labor hours as the allocation base. When an employee posts time to a particular job, the overhead rate for the employee's department multiplied by the employee's time charged to the job is the amount of overhead for that department charged to the job.
ProblemwiththeLingleAerospacejob
Chris Maynard contacts Phil Sanchez, supervisor of the welding department, and asks about the discrepancy between Maynard's estimate of 6.0 hours in the welding department and the 9.5 hours actually charged to the LA contract. Sanchez admits that there were two other jobs in the welding department at that time and that it is possible the employee had mistakenly charged some time to the LA contract instead of the other jobs.
Maynard then asks Linda Rawlings, supervisor of the drilling department, about the 67 labor hours charged to LA. Maynard had estimated the drilling time to be 53 hours for the batch. Rawlings said she was too busy now to look into the matter but she would contact him later. That was two weeks ago. Maynard is concerned that if the costs charged to the LA contract are too high, Phil Matson will ask LA for a higher price. If this happens, LA might shift the radar housing from Owens to another supplier.
When Jack Spence learned of the accounting errors on the LA account, he replied, "I don't see any problem. As long as the time cards are charged to jobs, our tax returns are right."
Required:
a. Identify various problems at Owens.
b. What improvements would you suggest Owens implement?

Employees' Incentives to Mis-State Product Costs