Question

Steve Morgan, controller for Newton Industries, was reviewing production cost reports for the year. One amount in these reports continued to bother him—advertising. During the year, the company had instituted an expensive advertising campaign to sell some of its slower-moving products. It was still too early to tell whether the advertising campaign was successful. There had been much internal debate as how to report advertising cost. The vice president of finance argued that advertising costs should be reported as a cost of production, just like direct materials and direct labor. He therefore recommended that this cost be identified as manufacturing overhead and reported as part of inventory costs until sold. Others disagreed. Morgan believed that this cost should be reported as an expense of the current period, so as not to overstate net income. Others argued that it should be reported as prepaid advertising and reported as a current asset. The president finally had to decide the issue. He argued that these costs should be reported as inventory. His arguments were practical ones. He noted that the company was experiencing financial difficulty and expensing this amount in the current period might jeopardize a planned bond offering. Also, by reporting the advertising costs as inventory rather than as prepaid advertising, less attention would be directed to it by the financial community.

Who are the stakeholders in this situation?

What are the ethical issues involved in this situation?

What would you do if you were Steve Morgan?

Answer 1

1. Stakeholders in the current situation are
   • readers of the cost reports
   • people who are engaged in the preparation of financial statements.
   • investors who would be subscribing the bond offering.
   • Shareholders of the company.
2. Ethical issues involved in this situation are:
   • Misrepresentation of the actual facts whether the advertisement campaign yeilded in positve outcome or not.
   • in case advertisement cost incurred in included in the cost of the production and shown as part of inventory, cost of production disclosed is not accruate as advertisement and marketing costs are to be disclosed as selling and distribution overheads.
   • in case the advertisement cost incurred is shown as a inventory , which means the balance sheet is being inflated which is considered as misleading the readers of the financial statements.
   • in case the advertisement costs are disclosed as inventories, the ratios calculation for presentation of financial statements would be incorrect.
3. If i was Morgan, i would facilitate an arrangement as the yeild or outcomes of advertisement cost incurred for pushing the sales of the slow moving products is not fully realised and as the company is also not in a position to state whether the cost incurred is effective or not. Expected total sales upon incurring the huge advertisement cost should be taken from marketing team. Expense off the advertisement cost incurred proportionately to the extent of actuals vs budgeted sale. The balance amount of advertisement cost would be in prepaid expense and would be expensed over a period of time.
4. As the total advertisement cost is not expensed off in single period that wouldnt adversely impact the financials and the issue of bonds