Question

Ethical Issues

"Maria, do you have a minute?" Josey asked the COO after stopping her in the hall.

"If it's quick, I do. I'm on my way to a meeting in a few minutes with the rest of the executive team."

"I'll only take a minute. I've been going through the numbers your team gave me about the new line, "Josey said as they slipped into an alcove in the lobby, out of the foot traffic of the main offices.

"Is there a problem?" Maria asked, concerned.

"I don't know. That's why I thought I'd ask. I went down to the floor the other day to do a spot check on some inventory. I noticed that the ending inventory is still pretty rough"

Maria smiled. "Well, we're moving as fast as we can, but we can't work miracles, even with a new line that is making TONS of money"

"That's not it. How fast you move is none of my business. My concern is that it was reported as being 74% completed for DM and 26% completed for coversion costs. But it doesn't look like it's that far along. I mean, to me it looked only about 50% done with materials and 5 or 6% done with conversion. Am I missing something?"

"Probably, but I see your point." Maria glanced up and down the hall. "Look, sometimes line managers are a little...generous with their estimates of how far along they are in production. It makes them look better, and it gives us better numbers. Because none of them really exaggerate too much, I usually look the other way. I mean, the effects, as far as I can tell, are minimal on the financial statements. Because it doesn't really change anything. I Just let it go."

"But..."

"Josey, I already know about it, and I don't think that it's a big deal, okay? These are my managers, my area. You need to let me handle it. It's my call. Now," Maria continued before Josey could speak. "I have to get to my meeting, or I'll be late. Call me sometime, and we'll do lunch."

Question 1: What effect will the line managers' generous estimates have on the company's financial statements? What effect might they have on the company's taxes?

Question 2: Josey walked away from this short interview feeling very uncomfortable with Maria's answers. Knowing GAAP as well as she does, Josey feels that this is an inappropriate decision that will skew the company's financial numbers and misrepresent their position. What can Josey do to change this company's policy?

Answer 1

1. The effect of the generous estimates would have the effect of overstating the valuation of ending inventories, which would result in overstating net income and retained earnings. By adding costs to inventories helps the managers to defer costs to the next accounting period, and makes both the income statement and the balance sheet to look better. Higher profit, and higher value for ending inventories would be the effect of the practice being followed by Maria's team.

As net income gets overstated, the company's income taxes would be higher.

2. Josey should bring the matter to the attention of the board of directors of the company. As the board is manned by independent directors ( who are not concerned with the day to day management of the company ), it is expected that whatever they decide would be in the best interests of the company and all its stakeholders.

If the company has an ethics committee, Josie can communicate his concerns to the committee in writing.

If nothing works, and Josie is uncomfortable with the work ethics of the organization, he should start looking for another job.