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.

Required

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

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

Please write a paragraph for each question. "Thank You"

Answer 1

Solution:-

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

Ethics are beliefs that distinguish right from wrong. They are accepted standardsof good and bad behavior. Since the goal of accounting is to provide usefulinformation for decision-making, such information must be trusted. Therefore,ethics is very important in Accounting.

When we analyze whether there is any ethical dilemma in the case of Bly, weshall follow the three steps - identifying ethical concern, analyzing option andmaking ethical decision.

In this case, the ethical concern is that varying the estimated warranty expensewould affect the amount of bonus Bly gets, as it is based on the Company revenueearned by selling autos in the year less the related warranty expenses. Thiscauses an ethical dilemma for Bly when choosing the appropriate warrantyexpense accrual percentage, in which such decision would ultimately affect hisincome.

Before analyzing the options of Bly, we shall first understand how to calculate thewarranty expense so that we can know more on how varying the percentage inestimating will affect Bly’s income.

Warranty expense this year= Estimated warranty liabilities this year X Percentage estimated

There are two options for Bly; the first one is to fulfill his self-interest bychoosing the least percentage over the prior 10 years (3%) to estimate theexpense in order to maximize the bonus he receives. Another option is to followthe Conservatism Principle by choosing the highest percentage over the prior 10years (10%) to estimate the expense, in which would reduce the amount ofbonus he earns to the minimum. It is therefore obvious that the ethical decisionfor Bly is to follow the Conservatism Principle and estimate the warrantyexpenses on the high end (10%).

2.Since warranty expenses vary, what percent do you think Bly should choose for the current year:-

Since actual warranty expenses vary, the estimation of the warranty expenseshould be based on the Company’s long-run average and its recent experiences.However, due to the lack of information provided, it is not appropriate to fix on aparticular percentage, as it may not truly reflect the current situation theCompany is facing. Therefore, based on the Consistency Principle andthe Conservatism Principle, our group has chosen a range of percentages onthe high end (8-10%).