Analyzing the effect of cost allocations Garcia Construction Company builds bridges, roads, commercial buildings, and other large projects. All projects are administered and accounted for from the firm's central office. The cost of operating Garcia's central office facility is $2,400,000 a year. The cost of administering projects is a major cost of some projects and the cost must be assigned to all of the state government contracts in order to charge the correct amount for the construction project.

All contracts with private sector companies are negotiated fixed-price contracts. Construction costs for these projects are accumulated to help management evaluate the profitability of projects and the performance of construction supervisors. All state government contracts are based on the total cost of the construction project plus a 15 percent profit margin. Garcia must account for the cost of these projects in order to be paid for the state contracts.

The state government audits Garcia's records for the cost of all state government construction contracts. One point of contention has been the allocation of central office administration costs to state contracts. Garcia has been allocating these costs on the basis of the number of construction labor hours worked on the projects. The state auditor's office believes the office administration costs should be allocated based on the total dollar cost of construction contracts excluding the central office administration costs. Garcia's management argues that this change in the allocation procedure would have no impact on charges to state contracts, but the state auditor's office is not convinced, citing their belief that because of the extensive use of subcontractors on many private sector contracts, they do not record as many construction labor hours as would be expected given the total dollar amount of the contract. As a result the private sector contracts are not assigned their fair share of the office administration costs.

Below are cost and construction labor hour data for each of the construction contracts worked on during the past year.

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Contract Number State contracts: SC-445.. SC-447 SC-448. Other contracts: PS-276. PS-279 PS-280 PS-281 Totals Total Cost Assigned to Contract Excluding Central Office Costs $ 2,200,000 3,000,000 800,000 Construction Labor Hours 140,000 200,000 50,000 1,200,000 20,000 500,000 10,000 1,500,000 60,000 800,000 20,000 $10,000,000 500,000 REQUIRED a. Compute the amount of office administration cost charged per construction labor hour using the company's current system. b. Compute the amount of office administration that would be charged per dollar of construction cost using the state auditor's suggested allocation approach. c. Compute the amount of overhead that would be charged to state contract SC-447 using each of the cost allocation alternatives. d. Compute the difference in the amount paid to Garcia Construction Company for contract SC-447 using each of the two cost allocation methods. e. Comment on which of the two alternatives should be used.