Concrete Recommendation about Overhead Allocation Harvard Case Solution & Analysis

With respect to the new CEO Mr. Chung Hae, this report is preparedwith strong potential criteria of the cost overhead allocation. Basically there are two approaches of the cost allocation with respect to the different industry. The first approach of the cost allocation is Traditional Approach in which cost is allocated on the basis of signal variables which may be the machine time, labor hour or total revenue etc. The second approach is Activity Based Approach in which costs are allocated on the basis of certain cost drivers according to their actual costs.

Furthermore, the impact of both the cost methods on Head quarter over heads is done in excel sheet. In the traditional costing method the profitability in 2008 is lower as compared to 2009. This effect is because of wrong basis for cost allocation. Basically the costs are charged on the basis of a single driver and are not based on actual cost expense related to each activity’s cost driver. On the other hand, Activity Based Costing allocates the costs with respect to the different cost driver for each activity. For justifying this problem and their way out consider the next heading which is given below:

Current Challenges and their Way-out

The main problem is how to fairly allocate the extra cost and what are strategic approaches to resolve it. By doing cost analysis with cost allocation techniques, results show that previously cost was apportioned with$8.47 in 2007 and $13.03 in 2008. That’s why the profit has decreased because all the costs are allocated on the basis of total base revenue. Due to this reason, Kim wanted to cover the extra costs incurred by increasing the company’s revenue. This problem occurs due to charging more costsunder different cost objects. To resolve this problem, the company has analyzed the activity based costing method which will improve the cost relationship with profit margin. In 2008, the profit margin increased to 64% which reflects the profit cost distribution under Activity Based Costing method. Furthermore, the cost in total increases from prior year by6% and profit is improving more than this cost incremental percentage. Now thecompany is planning to re-engineer its processes regarding the costapportionment. The analysis depicted in the Appendix-Ashows the allocation of costs and revenue under both approaches. Moreover, the calculation is done in excel file for understanding the appendices.

Activity Based Costing (ABC) Importance

The merit of the ABC method is to ascertain the cost with direct recipient of the cost object. This method will give fair values for the cost allocation because every object incurs its own costs rather than for others. If the overhead cost of individual activities is combined and allocated on the basis of a single variable (machine hours, labor hours etc), then the cost allocation is not fair which impacts negatively on profitability. This method is applied to those industries that have separate identifiable cost driver for each cost activity. On the other hand, where cost allocation basis are not given then the traditional method is the best approach. The disadvantage of this methodis identification of the appropriate cost drivers for each activity and there is also the risk involved that whether the cost drivers decided reflect the true nature of cost centers. Apart from ABC, general expense is directly curtail from sales


Therefore, the recommended approach for overhead allocation is ABC based on the analysis done which are annexed in this report. The reason and suggestion is because it allocates the actual cost fairly and shows the difference between the current year profits compared with the prior year profits. The traditional method pressurized the management due to higher costs and low profit margins and it also reduced the motivational level of the employee because of the low.................

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