Division cost allocation, R&D, ethics. World Semiconductor (WS) has eight divisions. It has a central R&D group in Waterloo that conducts contract research for each ofthese eight divisions.

At the start of each year, each division estimates the hours of research scientist time at the Waterloo group it will use in the coming year. These estimates are summed for WS as a whole.

Each division is charged for budgeted overhead costs incurred at the Waterloo facility on the basis ofits relative budgeted percentage use ofresearch scientist time in the coming year. Central R&D bears the risk of any overruns on overhead costs during the year. Each division also pays (in 2007) the Waterloo facility $100 per hour of research scientist time and the actual costs of any materials used on the project.

Toni Goodwin is the controller of the Applied Semiconductor Division (ASD), which is based in Regina, Saskatchewan. She notes that in the first nine months of 2007, ASD was charged $12,597 million for contract research at the Waterloo facility:

Research scientist time $ 2,564,000 Materials and other direct charges 2,883,000 Overhead cost charge (22% of $32,500,000) 7,150,000

$12,597,000 The $32,500,000 amount represents WS’s budgeted overhead costs for the first nine months of 2007.

It is now time to prepare the 2008 budget. Goodwin estimates that ASD will have a 2008 budget of 30,000 hours of research scientist time at the Waterloo facility. This estimate is based on detailed interviews she has had with operating managers at ASD and on a recent ASD retreat, at which the strategy and operations for 2008 were finalized. Roy Masters, the new president of ASD, is less than pleased with the 30,000 budget number. Goodwin and Masters have the following conversation:

Goodwin: But Roy, you were at the retreat where we all signed off on the 30,000 number.

Masters: I was there, but I think “signed off’ is too strong a phrase. By all means use the 30,000 number in our internal planning and budgeting at A$D. However, I want you to tell Waterloo that we are budgeting for only 25,000 hours in 2008.

Goodwin: But. . .

Masters: But nothing, Toni. Everyone plays games in this company. This is the fourth division of World Semiconductor I have worked in. I know for a fact that in all my three prior divisions, we deliberately understated budgeted usage of research scientists to the Waterloo people at the start of each year. Anyway, Waterloo always artificially inflates its estimate of overhead costs for the coming year. They do it every year. Anyone who thinks this is a level playing field is more naive than my dog.

Goodwin: Roy, I have to think about this.

Masters: Don’t think too long, Toni. I want the senior managers on my team to be team players. The issue you face, Toni, is whether you want to remain on the team.

Required 1. Why might Masters want Goodwin to report 25,000 budgeted hours rather than 30,000 budgeted hours to Waterloo?

2. What steps might Waterloo take to reduce WS divisions’ understating their budgeted usage ofWaterloo research scientist time?

3. What should Goodwin do?