Question

Forber Inc., a manufacturer of breakfast cereals and snack bars, has experienced several years of steady growth in sales, profits, and dividends while maintaining a relatively low level of debt. The board of directors has adopted a long-run strategy to maximize the value of the shareholders’ investment. In order to achieve this goal, the board of directors established the following five-year financial objectives.

• Increase sales by 14 percent per year.
• Increase income before taxes by 15 percent per year.
• Maintain long-term debt at a maximum of 16 percent of assets.

These financial objectives have been attained for the past three years. At the beginning of last year, the president of Forber Inc., Andrea Donis, added a fourth financial objective of maintaining cost of goods sold at a maximum of 70 percent of sales. This goal also was attained last year.

The budgeting process at Forber Inc. is to be directed toward attaining these goals for the forthcoming year, a difficult task with the economy in a prolonged recession. In addition, the increased emphasis on eating helpful foods has driven up the price of ingredients used by the company significantly faster than the expected rate of inflation. John Winslow, cost accountant at Forber Inc., has responsibility for preparation of profit plan for next year. Winslow assured Donis that he could present a budget that achieved all of the financial objectives. Winslow believed that he could overestimate the ending inventory and reclassify fruit and grain inspection costs as administrative rather than manufacturing costs to attain the desired objective. The actual statements for 2018 and the budgeted statements for 2019 that Winslow prepared are as follows:

Forber Inc Income Statement
	2018 Actual	2019 Budgeted
Sales	$850,000	$947,750
Less: Variable costs:
Cost of goods sold	510,000	574,725
Selling and administrative	90,000	87,500
Contribution margin	$250,000	$285,525
Less: Fixed costs:
Manufacturing	85,000	94,775
Selling and administrative	60,000	70,000
Income before taxes	$105,000	$120,750

Forber Inc Balance Sheet
	2018 Actual	2019 Budgeted
Assets:
Cash	$10,000	$17,000
Accounts receivable	60,000	68,000
Inventory	300,000	365,000
Plant and equipment (net of accumulated depreciation)	1,630,000	1,600,000
Total	$2,000,000	$2,050,000
Liabilities:
Accounts payable	$110,000	$122,000
Long-term debt	320,000	308,000
Stockholders’ equity:
Common stock	400,000	400,000
Retained earnings	1,170,000	1,220,000
Total	$2,000,000	$2,050,000

The company paid dividends of $27,720 in 2018, and the expected tax rate for 2019 is 34 percent.

Required:

1. For each of the financial objectives established by the board of directors and the president of Forber Inc., determine whether John Winslow’s budget attains these objectives. Support your conclusion in each case by presenting appropriate calculations and use the following format for your answer. (8 marks)

    Objective           Attained/Not attained        Calculations

2. Explain why the adjustments contemplated by John Winslow are unethical, citing specific standards of ethical conduct for management accountants.

Answer 1

S.No.	Objective	Attained/Not attained	Calculations
1	Increase sales by 14% per year	Not attained	2019 increase in sales over 2018 = ($947,750-$850,000)/$850,000 * 100 = 11.5%
2	Increase income before taxes by 15% per year	Attained	2019 increase in income before taxes over 2018 = ($120,750-$105,000)/$105,000 * 100 = 15%
3	Maintain long-term debt at a maximum of 16% of assets	Attained	2019 proportion of long-term debt to total assets = $308,000/$2,050,000 * 100 = 15.02%
4	Maintain cost of goods sold at maximum 70% of sales	Attained	2019 proportion of cost of goods sold to sales = $574,725/$947,750 * 100 = 60.64%

Further, the adjustments planned by Winslow are unethical for the following reasons:

1. He contemplated overestimation of ending inventory : He is violating the ethical standard of credibility by not reporting fair value of inventory but instead over reporting ending inventory which would lead to increase in total assets base and help in meeting objective of maximum 16% of total assets as long-term debt.

2. He contemplated reclassifying fruit and grain inspection costs as administrative costs rather than manufacturing costs: The accountant is violating the principle of competence whereby he is wrongly classifying manufacturing costs under the head ‘administrative costs’ so as to reduce the cost of goods sold ratio to total sales.