Emma Hanks, manager of a division that produces valves and castings on a special order basis, was excited about an order received from a new customer. The customer, a personal friend of Bob Johnson, Emma's supervisor, had placed an order for 10,000 valves. The customer agreed to pay full manufacturing cost plus 25 percent. The order was timely since business was sluggish, and Emma had some concerns about her division ability to meet it targeted profits. Even with the order, the division would likely fall short in meeting the target by at least $50,000. After examining the cost sheet for the order, however, Emma thought she saw a way to increase the profitability of the job. She reached for the phone to call her division controller, Lenny Cabot, CMA.

A few minutes later, Lenny met Emma in her office. Emma explained her plan to increase the profitability of the valve job. As currently written, the cost sheet reflected an allocation of maintenance costs to the Grinding Department based on maintenance hours used. In fact, sixty percent of maintenance costs were allocated to Grinding on that basis. But suppose that machine hours were used as the allocation base instead of maintenance hours? Then the allocation ratio would increase from 60% to 80%. This change would result in an increase of $10 per unit of the job. With the 25 percent markup, the revenues on that job would jump by $12.50 per unit increasing the profitability of the division by $125,000. At that point, Emma asked Lenny to change the allocation base from maintenance hours worked to machine hours.

Lenny protested briefly, pointing out that considerable time had been spent assessing the causal relationships. He and the management team found that maintenance hours reflected the consumption of maintenance cost much better than machine hours. He worried that the change would not result in a fair cost assignment. Finally, he reminded Emma that the maintenance hours had been used as the allocation base for maintenance cost for several years.

Emma brushed aside Lenny protests, saying that allocations are arbitrary anyway. She pointed out that changing the allocation base for this new job would increase the profitability and allow their division to meet targeted profit goals for the year. Their ability to get the capital they needed to expand the business depended upon meeting profit goals, as did their likelihood of receiving year-end bonuses. She also reminded him that the new customer had a prosperous business and could easily afford to pay somewhat more for this order.
1. Evaluate Emma's position. DO you agree with her reasoning? Explain. What should Emma do?

My answer: No. I do not agree with Emma's reasoning as it unethical to change the method of allocation of maintenance costs for the sake of attaining target divisional profit and to get the bonus.

As there is no direct relationship between maintenance costs and direct machine hours, it is unethical to charge heavy price simply because the customer is willing to pay cost plus 25%. If the customer come to know about the other companies willing to sell the product at a lower rate, he will switch over and Emma might eventually lose the customer. Furthermore, Emma, being a manager of a division, has to act in accordance with the standards of ethical conduct where in this case would be integrity.

Emma has to consider the long term growth of the company instead of the short term profits she could gain. Emma should also instead practice activity based costing and look at the ways to gain customer trust.

2. If you were the controller, what would you do? Do any of the standards for ethical conduct for management accountants apply to the controller?

My answer: If I were the controller, I do not agree with Emma and I would proceed with accepting the new order with the present system of allocating the costs to the Grinding department and the price will be fixed on the basis of that costs.

Yes, the standards of conduct for management accountants do also apply to Lenny, the controller.

Lenny is a division controller as well as a certified management accountant (CMA) and as shown in the case. This certificate indicates that the holder has demonstrated competency of technical knowledge required by the IMA in management accounting and financial management. IMA has issued a Standard of Ethical Conduct for Practitioners of Management Accounting and Financial Management. Practitioners of management accounting and financial management have an obligation to the public, their profession, the organizations they serve and themselves to maintain the highest standards of ethical conduct. Therefore, standards of conduct for management accountants apply to Lenny as well.

3. Suppose Lenny refused to change the allocation scheme, Emma then issued the following ultimatum: "Either change the allocation or look for another job!" Lenny then made an appointment with Bob Johnson and disclosed the entire affair. Bob however was not sympathetic. He advised Lenny to do as Emma had requested, arguing that the request represented good business sense. Now what should Lenny do?

4. Refer to requirement 3. Lenny decided that he cannot comply with the request to change the allocation scheme. Appeals to higher level officials have been in vain. Angered, Lenny submitted his resignation and called the new customer affected by his cost reassignment. In his phone conversation, Lenny revealed Emma's plan to increase the job's cost in order to improve the division's profits. The new customer expressed his gratitude and promptly canceled her order for 10,000 valves Evaluate Lenny's actions. Should he have informed the customer about Emma's intent? Explain.