Question

Ethical Issues

Jeremiah Wedgewood, the CFO, is adamant that the company needs to move ahead with the new line. While Josey also thinks that the new line is a good idea, she is a little worried about how it is going to affect their financial statements in the short run. After carefully considering what was likely to happen, Josey scheduled an appointment to visit with Jeremiah about her concerns.

"Josey!" Jeremiah said as she came into his office. "How are you doing today?" Josey smiled. Nothing ever seemed to really bother Jeremiah.

"I'm doing well, thanks, Uncle Jerry. Just a little worried about our new line."

"Worried?" Jeremiah asked. "About what?"

"Well, let me just start by saying that I agree that adding these new candles is a great idea. I think we have a really good idea of how much we can charge for them to break into the market and stay competitive in the long run. I also think while our costs will be high while we get the new line started, they will come down over time as we get settled. But I'm a little concerned about what the line will do to our profits for the next couple of years. The profits won't be nearly as good as they are for our traditional candles for at least two years."

"Well, Josey," Jeremiah replied, "keep in mind that this is a family-owned business, so that's not going to be a big deal. I mean, we don't have investors messing up our stock prices with every little piece of news. However," he paused, looking out his window for a moment as he thought about the changes. "We did just open up a new line of credit with our bank and our interest rate is contingent on maintaining profitability in each segment. Shoot! I didn't think about the new line when I signed that deal. They offered such a low rate that I wanted to make sure I locked it in." He looked at Josey. "We don't have to show a large profit, just a profit. What do you think our chances are of just being above zero with the new line?"

Josey shook her hand back and forth. "About 50-50, at least for the first year."

"That's not good enough," Jeremiah said, shaking his head. "What is we adjust the overhead allocation so that both lines show a profit?" Josey frowned. "Now, don't write me off as a bad guy, Josey. This wouldn't be right if we were a public company because we would be misleading investors, but, as I said, we don't have any investors, just the family.

"What about the bank?" Josey asked.

"Well think about it," Jeremiah said, a smile again forming on his lips. "They really just want to make sure that we pay them back, or that we have the cash to pay them back. What I'm talking about won't affect our cash flows at all. We're just shifting overhead from one line to another. Companies do that all the time."

Josey looked at Jeremiah and pondered. She was confident that the new line would be profitable soon, probably in just a year or two. And overhead is applied on a somewhat arbitrary basis, especially when using a single, plant-wide rate, or departmental rates. She chose all of those numbers anyway, after all. There was no way to really know if the amount of overhead being applied to any product was the "real" amount. Activity- based costing would get them closer to an actual cost, but she hadn't had time to get into that yet. And Jeremiah was certainly right; the last thing they needed now was for the bank to raise the interest rates over a bookkeeping technicality. Perhaps they could make a change to their overhead allocations...

Questions

1. Make a list of pros and cons of applying overhead strictly on the basis of specific departmental rates versus "adjusting" the allocations to keep each line profitable.

2. Review the four principles and four standards of the IMA's Statement of Ethical Professional Practice. Based on these principles and standards, do you believe that there are any ethical violations in Jeremiah's proposal? Explain which, if any, of the principles and/or standards Jeremiah's suggestion will violate. Does it matter that this is a family-owned company instead of one with outside investors? If there were no bank loan and Jeremiah wanted to do this just for internal reporting, would it change your answer?

Answer 1

1. Make a list of pros and cons of applying overhead strictly on the basis of specific departmental rates versus "adjusting" the allocations to keep each line profitable.

Answer: Pros: The Main benefits for applying overhead strictly on the basis of specific departmental rates against adjusting the allocation to keep each line profitable is to reach at the right conclusion, acual performance, to make healthy decisions for future, to stop particular line of business, concentrate more on profitable lines, improved efficiencies etc.

Cons: The Main losses for applying overhead strictly on the basis of specified departmental rates is to demoralise the particular department, particular line of business and the concerned staff. Many times particular line may not be beneficial in short term but in longer term that proves the most beneficial lines for the organisation. Many times we need to continue with particular line to maintain the customer relationship for all other lines.In that case the decision seems wrong to not to adjust the allocations to keep each line profitable. To attract Investors also, its beneficial to show all lines profitable.

2. Review the four principles and four standards of the IMA's Statement of Ethical Professional Practice. Based on these principles and standards, do you believe that there are any ethical violations in Jeremiah's proposal? Explain which, if any, of the principles and/or standards Jeremiah's suggestion will violate. Does it matter that this is a family-owned company instead of one with outside investors? If there were no bank loan and Jeremiah wanted to do this just for internal reporting, would it change your answer?

Answer: There are Four IMA's ethical principles :honesty, fairness, objectivity, and responsibility. The statement describes specific requirements for management accountants to heed according to the IMA's four standards: competence, confidentiality, integrity, and credibility. Jeremiah"s Proposal ethically voilates the Prinicpals of honestly & fairness. In addition the suggestions will deviate from the standards of competence and crediblity. Its being a family-owned company, one can go with deviating from the basic standards while keeping the integrity and confidentiality standards. To run the business is important more here, than that of theoritical standards. In absence of outside Investors, who may be at risk, its purely becomes a business decisions of family only. They must go ahead. if there is no Bank Loan than for internal reporting, We agree with Jeremaih's proposal. It will not change our answer.