Managerial Accounting Case Study Due In Week 4

Managerial Accounting Case Study – Due in Week 4 Read

Answer the following questions in 2-3 pages. Feel free to use outside sources: Sun Energy produces and distributes chemicals in its Southwest Division, which is located in San Antonio, Texas. Southwest’s earnings increased sharply in 2010, and bonuses were paid to the management staff for the first time in several years. Bonuses are based in part on the amount by which reported income exceeds budgeted income. John Smith, VP of Finance, was pleased with Southwest’s 2010 earnings and thought that the pressure to show financial results would ease.

However, Kay Marvin, Southwest’s division manager, told Smith that she saw no reason why the 2011 bonuses should not be doubled those of 2010. As a result, Smith felt pressure to increase reported income to exceed budgeted income by an even greater amount. This would ensure increased bonuses. Smith met with Tony Tiger of Millstone, a primary vendor of Southwest’s manufacturing supplies and equipment. Smith and Tiger have been close business contacts for many years.

Smith asked Tiger to identify all of Southwest’s purchases of perishable supplies as equipment on Millstone’s sales invoices. The reason Smith gave for his request was that Southwest’s division manager had imposed stringent budget constraints on operating expenses but not on capital expenditures. Smith planned to capitalize the purchase of perishable supplies and include them with the Equipment account on the balance sheet. In this way, Smith could defer the expense recognition for these items to a later year. This procedure would increase reported earnings, leading to increased bonuses.

Tiger agreed to do as Smith had asked. While analyzing the second quarter financial statements, Larry Lion, Southwest’s director of cost management, noticed a large decrease in supplies expense from one year ago. Lion reviewed the Supplies Expense account and noticed that only equipment but no supplies had been purchased from Millstone, a major source for supplies. Lion, who reports to Smith, immediately brought this to Smith’s attention. Smith told Lion of Marvin’s high expectations and of the arrangement made with Tiger of Millstone.

Smith told Lion that his action was an improper accounting treatment for the supplies purchased from Millstone. Lion requested that he be allowed to correct the accounts and urged that the arrangement with Millstone be discontinued. Smith refused the request and told Lion not to become involved in the arrangement with Millstone. After clarifying the situation in a confidential discussion with an objective and qualified peer within Southwest, Lion arranged to meet with Marvin, Southwest’s division manager. At the meeting, Lion disclosed the arrangement Smith had made with Millstone.

Questions to address

1. Explain why the use of alternative accounting methods to manipulate reported earnings is unethical.

2. Is Larry Lion, Southwest’s director of cost management, correct in saying that the supplies purchased from Millstone were accounted for improperly? Explain.

3. Assuming that John Smith’s arrangement with Millstone was in violation of the Standards of Ethical Conduct for Management Accountants, discuss whether Lion’s actions were appropriate or inappropriate.

Paper For Above instruction

Manipulating reported earnings through alternative accounting methods is fundamentally unethical as it undermines the integrity of financial reporting. Ethical standards in accounting emphasize honesty, transparency, and accuracy (AICPA, 2018). When management intentionally employs questionable accounting tactics—such as capitalizing expenses that should be recognized immediately—their primary motive is often to portray a healthier financial position than reality. This distortion misleads stakeholders, including investors, creditors, and employees, impairing their ability to make informed decisions (Nobes & Parker, 2013). Furthermore, such practices breach the professional code of conduct established by accounting bodies like the Institute of Management Accountants (IMA), which underscores the importance of honesty, fair presentation, and professional integrity (IMA, 2016). Manipulation to inflate earnings for bonuses not only violates these ethical principles but also erodes public trust in corporate financial disclosures and can lead to legal repercussions, including sanctions and reputational damage (Healy & Wahlen, 1999). In essence, the ethical breach occurs because such tactics prioritize personal or managerial gains over truthful representation, compromising the credibility vital to the accounting profession.

Larry Lion’s assertion that the supplies purchased from Millstone were improperly accounted for hinges on the distinction between capital and operating expenses. According to generally accepted accounting principles (GAAP), supplies are typically classified as operating expenses because they are consumed within the current accounting period (FASB, 2016). Capitalizing supplies—treating them as equipment—enables deferring expenses to future periods, artificially inflating current earnings. This practice misrepresents the true financial state and violates the matching principle, which requires expenses to be recognized in the period they are incurred to generate revenue (Kieso, Weygandt, & Warfield, 2019). The fact that supplies were purchased but not recorded as expenses, and instead were misclassified as equipment on the balance sheet, indicates improper accounting. Lion’s concern about this misclassification is justified, as such treatment creates a misleading picture of profitability and asset valuation (Jones, 2017). Accurate classification and timely recognition of expenses are fundamental to reliable financial reporting, and any deviation from these standards compromises the integrity of the financial statements.

If John Smith’s arrangement with Millstone involved capitalizing supplies improperly to inflate earnings and bonuses, it directly contravenes the Standards of Ethical Conduct for Management Accountants established by IMA (IMA, 2016). These standards emphasize integrity, credibility, and objectivity in the conduct of professional responsibilities. Engaging in practices aimed at manipulating financial results breaches the fundamental principles of honesty and fairness. Moreover, the decision to reclassify supplies as equipment without proper disclosure constitutes fraudulent accounting, which is explicitly unethical (Healy & Wahlen, 1999). Lion’s decision to disclose the arrangement to Marvin aligns with the ethical obligation to report violations of professional standards and prevent further misconduct (AICPA, 2018). Conversely, Smith’s refusal to correct the accounts and his attempt to conceal the inappropriate treatment reflect unethical behavior, undermining the credibility of the financial information. Therefore, Lion’s actions were appropriate and ethically justified, as they aimed to uphold the integrity of the financial reporting process and adhere to established ethical standards, despite the potential organizational repercussions (Shapiro, 2014). Protecting the profession’s reputation and ensuring accurate disclosures take precedence over preserving managerial misconduct.

In conclusion, manipulating earnings through improper accounting practices is unethical because it distorts the true financial health of a company, undermines stakeholder trust, and conflicts with professional ethical standards. Larry Lion’s recognition of incorrect accounting for supplies purchased from Millstone and his subsequent actions to disclose the misconduct exemplify ethical responsibility. Such conduct reaffirms the importance of integrity and objectivity in management accounting, serving as a safeguard for the credibility of financial reporting and the ethical standards that underpin the profession. Managers and accountants must prioritize transparency and honesty, even when facing organizational pressure or personal incentives, to maintain the public’s confidence and uphold the reputation of the accounting profession.

References

• American Institute of Certified Public Accountants (AICPA). (2018). Code of Professional Conduct. AICPA.
• FASB. (2016). Accounting Standards Codification: Expenses. Financial Accounting Standards Board.
• Healy, P. M., & Wahlen, J. M. (1999). A review of the earnings management literature and its implications for auditing practice. Auditing: A Journal of Practice & Theory, 16(2), 225-240.
• Institute of Management Accountants (IMA). (2016). Statements on Ethical Professional Practice. IMA.
• Jones, M. J. (2017). Financial Accounting and Reporting. Pearson.
• Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2019). Intermediate Accounting. Wiley.
• Nobes, C., & Parker, R. (2013). Comparative International Accounting. Pearson.
• Shapiro, D. (2014). Ethical dilemmas in management accounting: Why professional integrity matters. Management Accounting Quarterly, 15(4), 12-16.