Question

Cameron Bly is a sales manager for an automobile dealership. He earns a bonus each year based on revenue from the number of autos sold in the year less related warranty expenses. Actual warranty expenses have varied over the prior 10 years from a low of 3% of an automobile’s selling price to a high of 10%. In the past, Bly has tended to estimate warranty expenses on the high end to be conservative. He must work with the dealership’s accountant at year-end to arrive at the warranty expense accrual for cars sold each year.

Answer each of the following questions:

   1. Does the warranty accrual decision create any ethical dilemma for Bly?

    2. Because warranty expenses vary, what percent do you think Bly should choose for the current year?         Justify your percentage.

    3. What internal controls might be useful in overseeing Bly's recommendation for warranty expense?

Answer 1

(1): Yes, the warranty accrual decision does create an ethical dilemma for Bly. This is because his bonus is dependent on the warranty accrual decision and hence there is a conflict of interest. It is in Bly’s personal interest to maximize the amount of revenue less the amount of warranty expense so that his personal bonus is maximized. This is however not ethical as the warranty expenses should be properly estimated and accounted for as per the accounting norms and regulations.

(2): For the current year Bly should choose a percentage that is based on long term average with some extra weightage to current trend, because the experience of the company with warranties is quite varied. Bly should choose higher percentage of warranty in order to be conservative and at the same time he will be able to avoid accrued warranty expense in future.

(3): The internal controls that might be useful in overseeing Bly’s recommendation for warranty expense is that his recommendation should be analyzed and questioned by a senior finance and accounts manager. This scrutiny will ensure that Bly is making proper estimates for warranty expenses. Secondly Bly’s calculations should be cross checked with the figure as computed by an accounting software or as computed by another colleague. This will help in raising flags at appropriate time in case of any anomaly.