NMC feels it has a good handle on direct costs. Since the two divisions use different input materials, these costs are tracked by division rather than allocated to the two divisions.

Direct labour is allocated on the basis of manufacturing labour hours (MLH); New Wave generally uses 60% of total MLH but its focus on quality makes it relatively more labour/less capital intensive than Classic.

Thus, New Wave generally uses only 40% of total machine hours.

Carrying costs, like direct costs, are tracked by division and include storage space rental, insurance, spoilage and obsolescence. The first two items are recorded through third-party billing whereas the latter two items are determined by each division manager.

Variable overhead includes indirect labour such as rework labour, supervisor and plant manager wages as well as indirect materials such as scrap and warranty expense estimates. This cost category is allocated to the two divisions on the basis of MLH.

Bonuses to divisional managers are on the basis of Return on Investment (ROI). Returns are derived from gross margins, which are calculated using the allocation rules above. Upper management believes gross margins are also an appropriate measure to evaluate the two divisions

What are the weaknesses in their current cost allocation process and ways to improve it that will assist them in evaluating the performance of the Classic and New Wave divisions.

Be sure to discuss manager incentives for manipulating allocation methods to influence performance measures.?