Ruth Swazey, divisional controller and certified management accountant, was upset by a recent memo she received from the divisional manager, Paul Chesser. Ruth was scheduled to present the division’s financial performance at headquarters in one week. In the memo, Paul had given Ruth some instructions for this upcoming report. In particular, she had been told to emphasize the significant improvement in the division’s profits over last year. Ruth, however, didn’t believe that there was any real underlying improvement in the division’s performance and was reluctant to say otherwise. She knew that the increase in profits was because of Paul’s conscious decision to produce for inventory. In an earlier meeting, Paul had convinced his plant managers to produce more than they knew they could sell. By doing so, more of the fixed factory overhead could be moved into inventory with the extra units produced. He argued that by deferring some of this period’s fixed costs, reported profits would jump. He pointed out two significant benefits. First, by increasing profits, the division could exceed the minimum level needed so that all the managers would qualify for the annual bonus. Second, by meeting the budgeted profit level, the division would be better able to compete for much needed capital. Ruth had objected but had been overruled. The most persuasive counterargument was that the increase in inventory could be liquidated in the coming year as the economy improved. However, Ruth considered this event unlikely. Based on past experience, she believed that it would take at least two years of improved market demand before the productive capacity of the division was exceeded.
Required:
1. Discuss the behavior of Paul, the divisional manager. Was the decision to produce for inventory an ethical one?
2. What should Ruth do? Should she comply with the directive to emphasize the increase in profits? If not, what options does she have?
3. Review the Institute of Management Accountants “Statement of Ethical Professional Practice’’ found at www.imanet.org/ PDFs/ Statement of Ethics_ www.imanet.org/PDFs/StatementofEthics_web. pdf. Identify any standards that apply in this situation.