Assignment Question
Ethics : Blake Romney became Chief Executive Officer of Peters Inc. two years ago. At the time, the company was reporting lagging profits, and Blake was brought in to “stir things up.” The company has three divisions: electronics, fiber optics, and plumbing supplies. Blake has no interest in plumbing supplies, and one of the first things he did was to put pressure on his accountants to reallocate some of the company’s fixed costs away from the other two divisions to the plumbing division. This had the effect of causing the plumbing division to report losses during the last two years; in the past it had always reported low, but acceptable, net income. Blake felt that this reallocation would shine a favorable light on him in front of the board of directors because it meant that the electronics and fiber optics divisions would look like they were improving. Given that these are “businesses of the future,” he believed that the stock market would react favorably to these increases, while not penalizing the poor results of the plumbing division. Without this shift in the allocation of the fixed costs, the profits of the electronics and fiber optics divisions would not have improved. Now the board of directors has suggested that the plumbing division be closed because it is reporting losses. This would mean that nearly 500 employees, many of whom have worked for Peters their whole lives, would lose their jobs. How can cost allocation methods of fixed costs affect the profitability/unprofitability of a product or division? Was Blake’s request to his accountants ethical? Why or why not? What would be the consequences to the future profitability of the remaining divisions if the plumbing division were eliminated? How would you explain this to Blake? Reference Weygandt, J. J., Kimmel, P. D., & Mitchell, J. E. (2021). Managerial accounting (9th ed.). Wiley.
Assignment Answer
The Ethical Implications of Cost Allocation Methods in Corporate Profitability: A Case Study of Blake Romney and Peters Inc.
Introduction
In the ever-evolving landscape of business, corporate executives are often tasked with maximizing profits and shareholder value. One of the tools at their disposal is the allocation of costs, particularly fixed costs, among various product lines or divisions within a company. However, the ethical dimensions of cost allocation cannot be overlooked, as they can have far-reaching consequences for the company’s performance, its employees, and its stakeholders. This essay explores the ethical aspects of cost allocation methods and their impact on profitability, using the case of Blake Romney, the Chief Executive Officer of Peters Inc., and his decision to reallocate fixed costs to the plumbing division. It also discusses the potential consequences of closing the plumbing division and suggests a course of action that aligns with ethical principles.
Cost Allocation Methods and Their Impact on Profitability
Cost allocation is a fundamental practice in managerial accounting, allowing companies to assign costs to various products, services, or divisions based on certain criteria. This process is essential for decision-making, pricing strategies, and assessing the profitability of different segments of the business. In particular, the allocation of fixed costs can significantly influence the perceived profitability or unprofitability of a product or division.
Fixed costs are those that do not change with the level of production or sales. They include expenses like rent, depreciation, and salaries of permanent staff. When allocating fixed costs to different divisions, companies must choose an allocation method that aligns with their strategic goals and ethical standards. Common methods include direct allocation, activity-based costing, and allocation based on revenue or sales.
The choice of allocation method can have a profound impact on the reported profitability of each division. For example, if a company allocates fixed costs based solely on revenue, high-revenue divisions may appear more profitable, while low-revenue divisions might seem unprofitable. This can lead to misleading financial information and skewed performance evaluations.
Blake Romney’s Request and Its Ethical Implications
In the case of Blake Romney and Peters Inc., the ethical implications of his decision to reallocate fixed costs to the plumbing division are evident. Blake’s primary motivation for this move was not to accurately reflect the division’s performance but to enhance the apparent profitability of the electronics and fiber optics divisions. This raises several ethical concerns:
- Lack of Transparency: Blake’s reallocation of fixed costs was not transparent and did not accurately represent the true financial situation of each division. Transparency is a cornerstone of ethical financial reporting and decision-making.
- Manipulation of Financial Statements: Blake’s actions can be seen as a manipulation of the company’s financial statements to deceive stakeholders, including the board of directors and potentially, the stock market. Such manipulation undermines the trust of investors and can lead to legal consequences.
- Unfair Treatment of Employees: By artificially causing the plumbing division to report losses, Blake put nearly 500 employees’ jobs at risk. Many of these employees had dedicated their careers to Peters Inc., and their livelihoods were jeopardized due to the manipulated financial results.
- Short-Term Focus: Blake’s approach reflects a short-term focus on stock market perception rather than long-term sustainability and ethical responsibility. This can harm the company’s reputation and hinder its ability to attract long-term investors.
In summary, Blake Romney’s request to reallocate fixed costs to the plumbing division was unethical because it lacked transparency, manipulated financial statements, jeopardized employee livelihoods, and prioritized short-term gains over long-term ethical responsibility.
Consequences of Closing the Plumbing Division
The board of directors at Peters Inc. has suggested closing the plumbing division due to its reported losses. This decision could have several consequences, both immediate and long-term, on the remaining divisions and the overall company:
- Employee Layoffs: Closing the plumbing division would result in the loss of jobs for nearly 500 employees. This could lead to financial hardship for these individuals and their families, as well as a negative impact on the local community.
- Reputation Damage: Peters Inc.’s decision to close a division that has been a part of the company for years could damage its reputation in the industry and among stakeholders. Suppliers, customers, and investors may question the company’s commitment to its employees and long-term stability.
- Loss of Expertise: The plumbing division likely has employees with specialized knowledge and skills. Closing the division could result in the loss of valuable expertise that may be difficult to replace if the company decides to re-enter the plumbing market in the future.
- Impact on Suppliers and Customers: Suppliers and customers who have relied on the plumbing division may be disrupted by its closure. This could strain relationships and lead to lost business opportunities.
- Potential Financial Benefits: While the plumbing division may currently report losses, it is essential to consider the potential for profitability in the long term. With strategic adjustments and investments, the division might regain profitability and contribute positively to the company’s financial health.
Explaining the Consequences to Blake Romney
To help Blake Romney understand the consequences of closing the plumbing division and make an informed decision, it is crucial to approach the conversation with clarity and empathy. Here’s a suggested explanation:
“Mr. Romney, I understand your concern about the reported losses in the plumbing division and your desire to present a positive image to the board and the stock market. However, I’d like to discuss the potential consequences of closing the plumbing division:
- Employee Impact: Closing the division would result in layoffs for nearly 500 employees, many of whom have dedicated their careers to Peters Inc. This could have severe financial and emotional consequences for them and their families.
- Reputation Damage: Peters Inc. has built a reputation over the years, and closing a division may lead to questions about our commitment to our employees and long-term stability. Our stakeholders, including investors, suppliers, and customers, may have concerns.
- Lost Expertise: The plumbing division likely has employees with specialized skills and knowledge. Closing it may result in the loss of valuable expertise that could be challenging to replace.
- Potential for Profitability: While the division is currently reporting losses, we should also consider its long-term potential. With strategic adjustments and investments, it may be possible to turn it around and contribute positively to our company’s financial health.
I recommend a thorough analysis of the plumbing division’s operations and a consideration of alternative strategies before making a final decision. It’s essential to weigh the short-term financial implications against the long-term benefits and ethical responsibilities to our employees and stakeholders.”
Conclusion
The case of Blake Romney and Peters Inc. highlights the ethical dimensions of cost allocation methods and their impact on corporate profitability. Blake’s decision to reallocate fixed costs to the plumbing division for short-term gain raises significant ethical concerns, including transparency, manipulation of financial statements, employee well-being, and long-term responsibility. Closing the plumbing division, as suggested by the board of directors, could have far-reaching consequences for the company, its employees, and its reputation.
To make an informed decision, it is essential for Blake and the company’s leadership to consider not only the immediate financial implications but also the ethical responsibilities to employees, stakeholders, and the company’s long-term sustainability. This includes conducting a thorough analysis of the plumbing division’s operations and exploring alternative strategies to preserve jobs and expertise while maintaining the company’s integrity and reputation.
In conclusion, ethical considerations should always be at the forefront of decision-making processes within organizations, as they have a profound impact on the well-being of employees, stakeholders, and the company’s overall success.
References
Weygandt, J. J., Kimmel, P. D., & Mitchell, J. E. (2021). Managerial accounting (9th ed.). Wiley.
