Describe the Problem at Reed Park. Specifically Discuss Items Related to Decision Making, Cost Allocation and Incentives

1. Describe the problem at Reed Park. Specifically discuss items related to decision making, cost allocation and incentives

The current allocation system Reed Park is using is creating vast incentive problems with distribution center managers. Since Reed Park’s corporate overhead is now allocated based on the book value of the delivery trucks this creates a situation where the company’s cost system impacts the decision making process of the managers. In this case cost allocations work like an internal tax system (even though it is not a real tax) when new trucks are acquired by the distribution centers. This might lead to a situation where the DC managers are incentivized to make more deliveries with their current number of trucks, and not to invest in new equipment. Because of the allocation of the costs of new trucks the managers have now incentives to keep the old trucks, which are less reliable. The cost allocation system has lead to a situation where the drivers of DC trucks are complaining about being overburdened by their expanding routes and pressure to meet difficult delivery schedules. We can also see from the tables that the percentage of the overtime pay in relatively high. Stressed out workers also cost more for the company, they might go on sick leave or get burnout and therefore cannot work. This can be a big cause for the company in the long run. That is why it’s important to keep good care of the employees, so that they will be productive and successful in the future. Drivers were complaining that the routes were ever-expanding. If the drivers cannot meet the schedules the whole supply chain can suffer. Mistakes in shipping time can be costly and the company’s image can suffer if they get a reputation of not delivering on time.

 Company should also consider other factors, such as environmental factors and the old truck’s costs. Older trucks can consume more gasoline and be more hazardous for the environment, since they produce more harmful toxins for the environment.

This accounting system creates other problems as well, because of the system the cost of bottled water and the cost of trucks are not being charged to the distribution centers.Since both of these are “free” DC managers are more prone to making decisions that might be harmful for the whole company. Like Zimmerman affirms in an example of when it is appropriate to allocate common costs “if these two managers individually or collectively have the decision rights over the common resources but are not charged for the common costs, these costs will grow rapidly as the managers invent ways to substitute off-budget common costs for currently consumed inputs included in their budget. For example the usage of security guards, which are a common cost and not charged to either division. Now the division managers have an incentive to use security guards to perform maintenance, even though that is not their job description”. This kind of “dishonest” use of common cost can be extremely harmful for the company as a whole, and that is why the allocation of common cost needs to be thought out through roughly.

1. Describe alternative overhead allocation systems

Some alternative cost allocation systems that Reed Park Inc could use to better allocate the overhead costs to different cost centers more accurately.

I think the most accurate allocation system to use here would be allocation based on total subscriptions. In the assignment it is said that the majority of corporate overhead allocated to distribution centers results from the processing and maintenance of subscriptions and schedules. Thus since most of the corporate overhead expense results from these two, corporate overhead can be linked to the total number of subscriptions that every distribution center (Metro, Metro East, Metro West).

Another idea for an alternative overhead allocation system could be equal overhead allocation. Corporate overhead consist of functions that are necessary for the survival and success for all the distribution center. Corporate overhead like staff, administrative expenses and cost of office supplies used running the office are necessary for the company to survive. These kinds of expenses could be equally allocated among the three centers since they all need the corporate overheads in order to function. If there would be no need to control the expenses and revenues of east distribution center, the cost center’s could be combines which would result into the same situation.