Question

Emma Emerson is a proud woman with a problem. Her daughter has been accepted into a prestigious law school. While Ms. Emerson is proud of her daughter, she is worried sick about paying for the education - she is a single parent who has worked hard to raise her 3 children. She had to go heavily into debt to finance her own education. Even though she now has a good job, her family's needs continue to outpace her income and her debt burden is staggering. She knows she will be unable to borrow the money needed for her daughter's education.

Ms. Emerson is the chief financial officer (CFO) of a small manufacturing company. She has just accepted a new job and she hasn't notified her boss yet that she will be leaving in a month. She is concerned that her year-end bonus may be affected if her boss learns of her plan to leave. She knows her behavior is less than honorable but she believes that she in entitled to the bonus. Her boss makes twice what she does! She is considering an opportunity to boost the bonus.

Ms. Emerson's bonus is based on a percentage of net income. Her company recently introduced a new product line that required substantial start-up costs. GAAP requires these costs to be expensed in the current accounting period but if the costs are classified as product cost, net income will be higher. By the time the auditors discover the misclassification, Ms. Emerson will be at her new job. If her new employer hears about it, she can just claim ignorance.

Required:

1. Based on this information, do you think Ms. Emerson believes the number of units sold will be equal to, less than or more than production this year? Explain your logic.

2. Explain how the misclassification could mislead an investor or a creditor regarding the company's financial condition.

3. Explain how the misclassification could affect income taxes.

4. Review the Statement of Ethical Professional Practice shown in Exhibit 10.17 - is Ms. Emerson's misclassification of the start-up costs a violation of this statement?

Answer 1

1.Introducing new products into the marketplace ranges from being a relatively routine event for some companies to being a major decision for others. In either case, it is a complex resource and costing endeavor to model and understand.

Cost modeling focused on effective managerial decision support, such as Resource Consumption Accounting (RCA), improves the quality and availability of cost and resource capacity information for forward-looking simulations and performance feedback, necessary to make these decisions and evaluate and optimize operations. Let’s look at some of the key elements of new product decisions for a manufacturing organization.

• Nature of a new product decision: On the cost side, new product introduction is clearly a resource decision. It will be accomplished by acquiring new resources, reassigning or reprogramming existing resources, using idle resource capacity, or some combination of all three. The nature of the resources used is a key factor in the analysis. The costing approach must track both resource capacity quantities and the nature of the cost of that capacity (fixed or proportional).

Managers using RCA will be aware of excess capacity and, hopefully, incented to find profitable uses for it. This knowledge can also avoid unnecessary acquisition of new resources. If resources need to be reassigned, managers will have insight into marginal and incremental costs to evaluate the impact of changes in product mix.

• Product creation and design: This phase involves sales, marketing, R&D and production design. The managerial costing approach used must incorporate resources and processes throughout the organization, not just the elements of traditional product or service costing. Sales and marketing are traditionally flagged as SG&A (selling, general and administrative) period costs, but they contain strong links to product cost, customer cost, distribution channel cost, and many other dimensions of cost. Advanced costing approaches like RCA can model resources and processes for the entire organization.Financial accounting handles R&D as a period cost, but it is often dedicated to specific products or product lines. RCA uses an internal project to capture the resource effort and costs of product creation and design prior to the decision to implement. The project costs can then be factored into the profitability analytics (e.g., product lifecycle profitability) when the product is operational, or can be used more broadly to evaluate new product creation and design processes.
• Profitability analysis/projection:Companies using advanced managerial costing approaches will quickly be able to project changes to the existing resource mix, determine if new resources will be required to support projected product demand, and understand the impact of the resource changes to their cost structure. It is important to include changes to the sales and marketing resources, as well as production, production support, distribution and post-sales support.
• .Production testing and design::Once the product is designed, it is important to capture the resource effort and cost of designing/standing up a new production process. This period is normally captured in a project so the effort can be evaluated as part of long-term product profitability and as part of efforts to improve the new product introduction process.
• Routineproduction/operations:Advanced costing approaches provide ongoing information to evaluate resource quantity/capacity use and fixed and proportional costs. RCA supports plant floor optimization by identifying excess and idle capacity as production becomes more efficient, allowing capacity to be identified as available for increased demand, more new products, or cost reductionAdvanced managerial costing approaches focused on decision support create an integrated operations and financial model to provide managerial insights and information that traditional cost accounting—focused on external financial reporting—cannot begin to achieve.