A vice president of a company engaged in the following thought process at the end of the third quarter for his company.

"If I can increase my reported profit by $2 million, the actual earnings per share will exceed analysts expectations, and the stock prices will increase. The stock options that I am holding will become more valuable. The extra income will also make me eligible to receive a significant bonus. With a daughter getting ready to go to college, it would be good if I could cash in some of these options to help pay her college expenses. However, my vice president of finance indicates that such an increase is unlikely. The projected profit for the fourth quarter will just about meet the expected earnings per share. There may be ways, though, that I can achieve the desired outcome. First, I can instruct all divisional managers that their preventive maintenance budgets are reduced by 25 percent for the fourth quarter. That should reduce maintenance expenses by approximately $1 million. Second, I can increase the estimated life of the existing equipment, producing a reduction of depreciation by another $500,000. Third, I can reduce the salary increases for those being promoted by 50 percent. And That should easily put us over the needed increase of $2 million."

Required:

1. This type of scenario is called earnings management. Utilizing the concepts that you leaned in this module, and earlier modules, explain the type of costs (fixed, variable, semi-variable, etc.) that the vice president is contemplating manipulating.

2. Comment on the effect of the budget manipulations in general, as well as, the effect on the employees.

3. Does an ethical dilemma exist? If so, describe the dilemma.

4. How should the dilemma be resolved?

5. Is there any way to redesign the accounting reporting system to discourage the type of behavior the manager is contemplating?