Cost plus time and materials ethics a l mechanical

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13-30 Cost-plus, time and materials, ethics. A & L Mechanical sells and services plumbing, heating, and air-conditioning systems. A & L’s cost accounting system tracks two cost categories: direct labor and direct materials. A & L uses a time-and-materials pricing system, with direct labor marked up 80% and direct materials marked up 60% to recover indirect costs of support staff, support materials, and shared equipment and tools and to earn a profit. During a hot summer day, the central air conditioning in Michelle Lowry’s home stops working. A & L technician Tony Dickenson arrives at Lowry’s home and inspects the air conditioner. He considers two options: replace the compressor or repair it. The cost information available to Dickenson follows: Labor Materials Repair option 7 hrs. $120 Replace option 4 hrs. $230 Labor rate $45 per hr. Required: 1. If Dickenson presents Lowry with the replace or repair options, what price would he quote for each? 2. If the two options were equally effective for the 3 years that Lowry intends to live in the home, which option would she choose? 3. If Dickenson’s objective is to maximize profits, which option would he recommend to Lowry? What would be the ethical course of action? SOLUTION (20 min.) Cost-plus, time and materials, ethics. 1. As shown in the table below, Dickenson will tell Lowry that she will have to pay $759 to get the air conditioning system repaired and $692 to get it replaced. COST Labor Materials Total Cost Repair option (7 hrs. $45 per hr.; $120) $315 $120 $435 Replace option (4 hrs. $45 per hr.; $230) 180 230 410 13-31
PRICE (100% markup on labor cost; 60% markup on materials) Labor Materials Total Price Repair option ($315 1.8; $120 1.6) $567 $192 $759 Replace option ($180 1.8; $230 1.6) 324 368 692 2. If the repair and replace options are equally effective, Lowry will choose to get the air conditioning system replaced for $692 (rather than spend $759 on repairing it). 3. A&L Mechanical will earn a greater contribution toward overhead in the repair option ($324 = $759 – $435) than in the replace option ($282 = $692 – $410). Therefore, Dickenson will recommend the repair option to Lowry, which is not the one she would prefer. Recognizing this conflict, Dickenson may even present only the repair option to Michelle Lowry. Of course, he runs the risk of Lowry walking away and thinking of other options (at which point, he could present the replace option as a compromise). The problem is that Dickenson has superior information about the repairs needed but his incentives may cause him to not reveal his information and instead use it to his advantage. It is only the seller’s desire to build a reputation, to have a long-term relationship with the customer, and to have the customer recommend the seller to other potential buyers of the service, that encourages an honest discussion of the options. The ethical course of action would be to honestly present both options to Lowry and have her choose. To have their employees act ethically, organizations do not reward employees on the basis of the profits earned on various jobs. They also develop codes of conduct and core values and beliefs that specify appropriate and inappropriate behaviors.

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