Scenario: In Fall 2016, you are hired as Controller of the Medical Device division of Virtek. You report to Billy Bob, the General Manager of the division. Virtek has annual sales of approximately $1.7 billion. The Medical Device Division annual sales are approximately $170 million, about 10% of Virtek’s total annual sales. The Medical Device Division had a very good 2016. As you close the books for 2016 in January 2017, you are reporting a net profit of $21.6 million, well above the 2016 target profit of $20 million for the division. After reviewing the preliminary 2016 financial statements, Billy Bob says,
“We get our bonuses as long as we meet or exceed our $20 million target for net profit. It doesn’t help us to exceed the target by more than one and a half million, that will only encourage corporate to make our target that much higher for 2017. I want you to develop a rational for increasing our reserve for inventory obsolescence that will reduce our 2016 net profit to just over $20 million.”
By taking a pessimistic view of future market prospects, you are able to identify $1.25 million worth of inventory that under those market conditions could be justifiably fully reserved (written off) using conservative accounting. Billy Bob is pleased with the results you reported to him. He said,
“That’s very good! I’m fairly confident we can sell all that inventory in 2017 without offering any more than a small discount off our regular price. That will boost our 2017 net profit by nearly $1 million. With that extra cushion, we’re almost certain to achieve our 2017 earnings targets and our bonuses. I want you to book that adjusting entry to increase our inventory reserve for obsolescence. Oh, by the way, are you sure you can’t find another $200,000 or so of inventory we could write off in the same manner? It wouldn’t hurt to have even more of a cushion.”
You were a little uncomfortable reviewing inventory for obsolescence with a specific target value in mind, and following the meeting with Billy Bob, you decide that before you book the adjusting entry to increase the inventory reserve for obsolescence as he instructed, you want to review the entire situation before proceeding.
1. What are the ethical issues?
2. who are the stakeholders?
3. what is a more ethical alternative?