Rauren Odger (friends call him RO) was recently hired by Jets Cargo LLC as a controller. He was formerly employed by Send Him Packing CPAs. This CPA firm performs an annual audit to ensure Jets are playing by the rules and all information released to the public is presented in fair, accurate and ethical manner.

RO first duty was to develop a predetermined overhead rate for 2023. This rate is important to the Jets since it is used continuously throughout the year as a method to apply overhead and misapplied overhead is closed out to cost of goods sold. This seemed simple enough. He used the production manager (Joe Namath) estimate of production hours (310,000) and the manufacturing overhead estimated for the year ($2,015,000) and developed the predetermined oh rate (POHR). The estimated manufacturing overhead was established by using 2022 numbers as a baseline and then adjusting for 2023 based on changes in expected demand. This rate was applied to manufacturing costs.

RO brought this calculation to his immediate supervisor, Chief Financial Officer (Elijah Moore, the BIG E). RO was caught off guard by the demand of BIG E (maybe it was a suggestion) that he amend the estimate of production hours down to about 280,000 hours. RO explained his reasoning and his discussions with Namath, but BIG E became insistent that RO needed to reduce that estimate of production hours.

Finally, BIG E explained more thoroughly. By shaving off the estimate of production hours, Jets could produce a nice little kicker at the end of the year (when actual results adjusted this reserve account). When misapplied overhead was closed out to COGS it was like magic and an income boost. Rather than letting the income boost fall to retained earnings, management paid holiday bonuses. It was like magic and made everyone happy, why change now.

1.) Explain in detail (using sample (made up) numbers- how the manipulation of predetermined overhead rate could result in a net operating income boost at year-end. Would it really create income?

2.) Should RO go along with this and be the team player / Why or why not?

3.) What ethical standards should RO be concerned with?

4.) If this idea does create income, where does the cash come from?