Question

Bell Products Corporation manufactures after-market clutch plates for motorcycles, automobiles, racing applications, and heavy industry vehicles. One of the first stages of clutch plate production is to stamp the raw plates out of rolls of metal. The process requires the use of 100 ton presses that stamp out hundreds of plates per minute.

A chemical is used to keep the presses from overheating and is automatically sprayed in fractions of seconds to keep the press operating smoothly to lubricate and prepare the metal. The chemical also keeps the press from sparking during the punching process. A small spark could cause a fire and safety hazard. Therefore, the chemical is crucial to the operation of the stamping process.

The stamping solution contains proprietary ingredients that are toxic and considered to be hazardous waste, and disposal must be through EPA approved methods. The cost to dispose of the chemical is many times greater than regular waste products.

Currently, Bell Products uses a traditional, volume-based costing system for its clutch plate products. Total manufacturing overhead for the period is allocated to the clutch plates based on machine hours.

Fred, who was recently hired, is the controller for Bell Products. He has five years of experience as a cost accountant at a lumber manufacturing facility. At the lumber plant, Fred implemented an activity-based costing system that helped the plant manager determine the profitability of various product lines. After getting to know the manufacturing process at Bell Products, Fred has determined that an activity-based costing system would help management make better decisions and track the costs of the clutch plates more accurately.

Tina is the manager of the stamping department and is good friends with Fred. Tina runs a very efficient department and has earned several bonuses for the stamping department’s production and profitability. Each of the department managers are evaluated based on the profitability of the departments based on internal cost reports.

If activity-based costing is used to allocate costs and the hazardous waste of the stamping chemical is allocated to the department that uses the product, the internally calculated profits of the stamping department would decline drastically. The decline in profitability would be due to the extreme high cost of the stamping chemical and this cost would be directed allocated to the stamping department.

Tina decides to take Fred to an expensive restaurant and eventually brings up the activity-based costing system. She voices her concern about the allocation of the hazardous waste being directly allocated to her department. She asks Fred if there is any way that he could reduce the amount of hazardous waste allocated to the stamping department. Fred values Tina’s friendship and realizes that she is on the compensation committee that evaluates Fred on an annual basis. Fred definitely wants to keep Tina happy and on his side.

As a result, Fred decides to not setup a cost pool for hazardous waste. He reasons that since the hazardous waste has always been a part of the manufacturing process, he will bury it as part of the manufacturing costs that are allocated across all departments. He justifies his decision because the activity-based system will still accurately allocate all other costs and it is much more accurate than the old traditional costing system. Fred feels no one will get hurt. Since the activity-based costing cannot be used for external reporting, Fred feels that his decision is not illegal.

Using the Institute of Management Accountants Statement of Ethical Professional Practice on page 12 of your textbook (Exhibit 1-6) as an ethical framework, answer the following questions:

What are the ethical issues in this case?

1. Activity-based costing cannot be used for external reporting. Does this fact influence your analysis of whether Fred has violated any ethical principles? Why, or why not?
2. Do you agree with Fred that no one will get hurt by burying the hazardous waste into the general manufacturing cost pool shared by all departments? Explain.
3. What are Fred’s responsibilities as a management accountant? What should he do now?

Answer 1

Requirement 1: The ethical issues involved in the case can be discussed with regard to competence, integrity and credibility. Competence standard requires that the controller perform duties in accordance with relevant laws, regulations and technical standards and provide accurate, clear, concise and timely information. Integrity standards requires that he should not engage or support any activity that might discredit profession and carry out duties ethically. Credibility standard requires that information should be communicated not only fairly and objectively but also complete and relevant information that could reasonably expected to influence the decision maker.

Requirement 2: No, it is true that activity-based costing is not useful in external reporting because some period expenses like sales commissions which are allocated to specific products under activity-based costing should be expensed as incurred under the U.S GAAP. The behavior of controller violates competence, integrity and credibility of the ethical standards as mentioned in the Statements Ethical Professional Practice of the Institute of Management Accounts.     

Requirement 3: The controller is wrong in saying that no will get hurt because it will distort the cost allocated to the product and defeat the very purpose of implementing activity-based costing.

Requirement 4: As a management accountant, the controller should disclose all the relevant information and communicate it fairly and objectively.