Case Study # 1 – Managerial Accounting; Ethical Behavior

Stereo Technology, Inc. manufactures printed circuits for stereo amplifiers. A common product defect is a “drift” caused by failure to maintain precise heat levels during the production process. Rejects from the 100 percent testing program can be reworked to acceptable levels if the defect is drift. However, in a recent analysis of customer complaints, Marie Allen, the assistant controller, and the quality control engineer determined that normal rework does not bring the circuits up to standard. Sampling showed that about half of the reworked circuits will fail after extended amplifier operation. The incidence of failure in the reworked circuits is projected to be about 10 percent over five years.

Unfortunately, there is no way to determine which reworked circuits will fail, because testing will not detect the problem. The rework process could be changed to correct the problem, but the cost-benefit analysis for the suggested change indicates that it is not economically feasible. Stereo Technology's marketing analyst has indicated that this problem will have a significant impact on the company's reputation and customer satisfaction. Consequently, the board of directors would interpret this problem as having serious negative implications for the company's profitability.

Allen included the circuit failure and rework problem in her report prepared for the upcoming quarterly meeting of the board of directors. Due to the potential adverse economic impact, Allen followed a long-standing practice of highlighting this information. After reviewing the reports to be presented, the plant manager and his staff complained to the controller that he should control his people better. “We can't upset the board with this kind of material. Tell Allen to tone that down. Maybe we can get it by the board in this meeting and have some time to work on it. People who buy those cheap systems and play them that loud shouldn't expect them to last forever.” The controller called Allen into his office and said, “Marie, you'll have to bury this one. The probable failure of reworks can be mentioned briefly in the oral presentation, but it should not be mentioned or highlighted in the advance material mailed to the board.” Allen feels strongly that the board will be misinformed on a potentially serious loss of income if she follows the controller's orders. Allen discussed the problem with the quality control engineer, who simply remarked, “That's your problem, Marie.”

Required:

1. Discuss the ethical considerations that Marie Allen should recognize in deciding how to proceed.

2. What should Marie Allen do? Explain your answer.

This part will be evaluated based on the following criteria: breadth and depth of the argument/discussion (40%); coherence of argument/discussion (30%); ability to relate to managerial accounting and control (20%); and grammar and style (10%).

Case 2 – Budgeting; Financial Objectives; Ethics

Fit-for-Life Foods 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 12 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 Fit-for-Life Foods, 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 company's budgeting process 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 healthful 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 Fit-for-Life Foods, has responsibility for preparation of the 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 20x4 and the budgeted statements for 20x5 that Winslow prepared are as follows:

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