Ethics Case Study

Business Finance

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Please respond to the questions for this ethics case study

Respond in a Word doc with a full paragraph for each of the six questions

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The Case Situation Ryan sat at his desk reviewing the latest budget supporting schedules. He had only recently been hired as the Chief Accountant and was determined to learn all the details of this manufacturing firm. The firm was relatively small and straight forward; it manufactured a single product and wholesaled it to retail outlets, which in turn sold it to end consumers. Ryan raised his head in response to the raps on his office door frame. He recognized Sid, the Vice President of Sales, and waved him in through the already open door. “Hi Sid. What can I do for you?” Ryan queried. Sid responded. “I have a problem, but I also think I have a solution. Can I talk to you about it?” “Sure.” said Ryan. Sid began. “Ryan, you know what the economy has been like. It’s getting harder to keep sales up, let alone increase sales. Our competitors are under-pricing us and unless I can give the retailer some price discount, I’m not sure I will be able to meet our sales projection. Now, I’m not an accountant and I’m not sure I understand all the details, but, let me try to explain my understanding of the situation. You said in a recent budget meeting that we have to have a positive contribution margin, that is, the selling price has to be greater than the variable costs of production. Otherwise, we will not be generating any profits to offset our fixed production costs. As I understand it, the contribution margin from each unit we sell gradually eats away at the fixed costs until we have sold enough units to completely cover our fixed costs. You called that the ‘break-even point’. From that point on, the contribution margin from each unit sold adds to profits. Do I have that correct?” Ryan responded. “In a nutshell, you’ve got the concept right.” Sid continued. “Ok. Here’s the problem. Based on your briefing in the budget meeting, the CEO said that we MUST have a contribution margin of $2.00 per unit in order to achieve our desired pre-tax profit of $85,000, and I have to sell 200,000 units. I’m not sure I can sell 200,000 units. And if I can’t pay good commissions to my salespeople I stand a chance of losing some of my best salespeople. Here’s Figure 1, the handout you gave us at the budget meeting. It shows that because variable costs are $4.00, to get a contribution margin of $2.00, we have to sell each unit for $6.00. The problem is that we are being undercut by our competitors. They are giving discounts to the retailers and selling their versions of our product for less than $6.00.” Sid added. “I can’t reduce our price unless we can reduce our variable costs or our fixed costs. If we reduce our variable costs, then a $2.00 contribution margin can be achieved at a lower selling price. If we can reduce our fixed costs, then we can reach our desired pre-tax profit with a lower selling price.” “But,” Ryan interjected, “if you remember from the budget meeting, I also said that in the short-term we can’t appreciably change our cost structure. That’s a long-term solution.” “I know. I know.” said Sid. “But, I’ve been thinking about this. Right now, as was shown in your Figure 1 (Appendix), maintenance on the machines is budgeted as a variable cost of 60¢ per unit and the maintenance is repeatedly scheduled after a fixed number of units of our product are manufactured. Quality testing on a sample of our products is also budgeted as a variable cost of 10¢ per unit. Shoot! We’ve been making this product so long that virtually every unit is ok. Take my word for it, only a very small number of units ever fails quality testing that results in the machines having to be re-tuned. According to your numbers, if we produce and sell 200,000 units, total maintenance costs will be $120,000 and total quality testing costs will be $20,000.” “Those numbers are correct.” said Ryan. Sid continued. “What if you turned maintenance and quality testing into fixed costs and took them out of variable costs? The budgets for those two departments wouldn’t change; they would just become fixed costs. We won’t schedule maintenance after a fixed number of units are manufactured, we would simply schedule maintenance after a unit of time has passed, for example every two weeks. Same with quality testing. Instead of testing one in every 50 units, we would just take a fixed sample of units every week and quality test them. In this way the budgets of those two departments would be fixed and not based on the level of production.” Sid got even more animated. “Here look at what I prepared. In this hypothetical illustration, that I labeled Figure 2 (Appendix), I think I have the solution. By moving maintenance and quality testing to the fixed costs, we lower the variable costs per unit from $4.00 down to $3.30. This means that I can offer discounts to the retail outlets and sell our product to them for $5.30. We can still satisfy the CEO because the contribution margin stays at $2.00 per unit. Sure the break-even point goes up, but because of the lower selling price, I can actually sell more units … I project as much as 275,000 units. At this number of units being sold, the overall pre-tax profits will increase to $95,000. This will also increase sales commissions to my salespeople and I can keep them from leaving. THIS IS A WIN, WIN SITUATION!” Ryan raised a question. “What about the managers of maintenance and quality testing? Might they not raise a stink?” Sid retorted. “Don’t worry about them. I’ve been here longer than you and I know them both very well. Their overall budget remains the same and I can talk them into it, especially when I tell them that the Chief Accountant agrees with the plan. Besides, it will actually reduce their workload to keep a fixed schedule rather than having to schedule their work around how many units we produce. I’ll take care of it. All you have to do is rearrange the numbers and reduce variable costs.” “But,” Ryan interjected, “what about the factory? Won’t the Vice President of Manufacturing need to know that more units are going to have to be made? After all he needs to order more materials and make work schedules. Shouldn’t I make a new cost budget, like Figure 2, for everyone?” “Not a problem.” said Sid. “I will let the VP of Manufacturing know that I expect more sales and he will have to make another 75,000 units. He will be more than excited about that. We won’t need a new cost budget, because we aren’t changing anyone’s budget except for manufacturing. And they always respond to additional orders whenever my people sell more. In fact, they expect things like that to happen. If I were you I wouldn’t worry about changing and distributing the budget. Besides, the CEO is really going to be pleasantly surprised when at yearend we show him the great results we got.” The Case Requirements If you were Ryan, what should you do? In framing your analysis, address the following six requirements. 1. Based on the VP of Sales’ proposal, what is being asked of Ryan, the Chief Accountant? When answering this question, ask yourself what you know about the Chief Accountant, the VP of Sales, their goals and the nature of their relationship? What are the goals of the organization? 2. Who are the stakeholders that will be affected by how Ryan responds to the VP of Sales proposal? Describe how the request might affect each of the stakeholders? What is Ryan’s responsibility to each stakeholder? When answering this question, think about the people and organizational positions specifically identified in the case and think beyond those to people or organizations not specifically mentioned. 3. Put yourself in Ryan’s position. Just like Ryan, you do not know much about this firm. What would you research about how this organization is “run”? Are the budgets and measures of success appropriate within this firm? What would you need to find out about the ethical culture of the firm, the procedures, the policies, and the management decision making relationships that you would have to know in order to make a good decision about the VP of Sales’ request? 4. Discuss the professional standards the Chief Accountant should consider in deciding how to handle the VP of Sales’ request. Think about the specific professional standards itemized in the IMA’s Statement of Professional Ethical Practice.1 Which standards apply to Ryan in this situation? 5. Identify the Chief Accountant’s alternative options for responding to the VP of Sales’ proposal. Discuss the possible consequences and the organizational factors and professional standards applicable to each option. When answering this question, consider that Ryan could do any one of many different things, such as, agree, disagree, remain unsure of how he should respond to the proposal, etc. How should Ryan proceed under each alternative option? The case is not explicit about what corporate guidance exists to resolve ethical dilemmas, so you may have to consider hypothetical alternatives. 6. Which of the options would you recommend to the Chief Accountant? Explain your reasoning for selecting that option. Discuss your recommended course of action with respect to resolving the ethical dilemma and the effect on the Chief Accountant. You should clearly outline and discuss your recommendation for Ryan’s course of action. The course of action should go beyond the limited and specific actions indicated by the IMA’s Statement of Ethical Professional Practice and should consider: (1) preserving good working relations within the organization; (2) how to improve the organization; (3) how to reduce ethical dilemmas in the future, and; (4) how to improve Ryan’s image within the organization by how he handles this issue. 1 Institute of Management Accountants Statement of Ethical Professional Practice, http://www.imanet.org/PDFs/Statement%20of%20Ethics_web.pdf. APPENDIX Figure 1: Ryan's Handout of the Current BEP and Budgeted Sales Per Unit 6.00 Produce & Sell BEP 157,500 Units $ 945,000.00 Produce & Sell Budgeted 200,000 Units $ 1,200,000.00 $ 1.00 1.40 0.40 0.60 0.10 0.50 4.00 $ 157,500.00 $ 220,500.00 $ 63,000.00 $ 94,500.00 $ 15,750.00 $ 78,750.00 $ 630,000.00 $ 200,000.00 280,000.00 80,000.00 120,000.00 20,000.00 100,000.00 $ 800,000.00 Contribution Margin (CM): CM = SP ─ VC $ 2.00 $ 315,000.00 $ 400,000.00 Fixed Costs: Advertising Fixed Salaries Depreciation Property Taxes Insurance Total FC Total $ 10,000.00 200,000.00 50,000.00 25,000.00 30,000.00 $ 315,000.00 $ 10,000.00 200,000.00 50,000.00 25,000.00 30,000.00 $ 315,000.00 $ $ $ Selling Price (SP): Variable Costs: Variable Materials Labor Utilities Maintenance Quality Testing Sales Commissions Total VC $ $ Total Pre-Tax Profits: Break-Even Point (BEP) Units: BEP Units = Total FC / CM 157,500 0.00 10,000.00 200,000.00 50,000.00 25,000.00 30,000.00 $ 315,000.00 85,000.00 Based on a $6.00 Selling Price Figure 2: Sid's Illustration of Modified BEP and Projected Sales Selling Price (SP): Variable Costs: Variable Materials Labor Utilities Sales Commissions Total VC Contribution Margin (CM): CM = SP ─ VC Fixed Costs: Advertising Fixed Salaries Depreciation Property Taxes Insurance Maintenance Quality Testing Total FC Per Unit $ 5.30 $ $ $ $ $ $ $ $ 2.00 $ 455,000.00 $ 550,000.00 $ $ Total 10,000.00 200,000.00 50,000.00 25,000.00 30,000.00 120,000.00 20,000.00 $ 455,000.00 $ 10,000.00 200,000.00 50,000.00 25,000.00 30,000.00 120,000.00 20,000.00 $ 455,000.00 $ 227,500 227,500.00 318,500.00 91,000.00 113,750.00 750,750.00 Produce & Sell Projected 275,000 Units $ 1,457,500.00 1.00 1.40 0.40 0.50 3.30 Total Pre-Tax Profits: Break-Even Point (BEP) Units: BEP Units = Total FC / CM Produce & Sell BEP 227,500 Units $ 1,205,750.00 0.00 $ $ $ $ $ Based on a $5.30 Selling Price 275,000.00 385,000.00 110,000.00 137,500.00 907,500.00 10,000.00 200,000.00 50,000.00 25,000.00 30,000.00 120,000.00 20,000.00 $ 455,000.00 $ 95,000.00 Based on Ryan's original budget Profit Increased ...
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