KAI uses an inappropriate volume- based cost allocation method that causes inefficient resource allocation, disincentive among employees and reduced net income. To improve the existing method, Senior Management should consider reviewing the current situation to identify problems, followed by adopting an alternative cost allocation method. The current method allocates resource based solely on revenues, causing inefficient resource allocation. It lacks consideration of each branch’s difference in cost structure. Many teams are allocated with excess overhead costs despite the irrelevant relationship between cost and revenues. For example, the Operating Support Team’s traffic accidents handling costs are not related to revenues generated by the branches. Instead, the number of accidents should be used as cost driver. While the number of accidents decreased by xx% from 54 cases in 2007 to 31 in 2008, the traffic accident handling costs still increased by xx% from $11.7 to $16.4 million. 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 are not rewarded with lower overhead costs and their earning targets are harder to be reached. For example, the IT team decreased the number of employees by xx % from 82 in 2007 to 45 in 2008. Yet, its overhead costs increased by xx% from $18.4 million in 2007 to $24.3 million in 2008. The General Administrative Team’s also decreased the number of employees from 2007 to 2008. Yet, education and training cost increased by xxxx% from $4.5 million to $5.1 million. The two teams’ intention to reduce cost was not recognized by the headquarters. Employees are discouraged by the allocation of excess overhead costs, which may weaken their productivity.
The inappropriate cost allocation method demotivates employees. The proportion of direct costs...
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