Question

Question: Cameron Bly is a sales manager for an automobile dealership. He earns a bonus each year based on revenue from the number of autos sold in the year less related warranty expenses. Actual warranty expenses have varied over the prior 10 years from a low of 3% of an automobile’s selling price to a high of 10%. In the past, Bly has tended to estimate warranty expenses on the high end to be conservative. He must work with the dealership’s accountant at year-end to arrive at the warranty expense accrual for cars sold each year.

1. Does the warranty accrual decision create any ethical dilemma for Bly?

2. Because warranty expenses vary, what percent do you think Bly should choose for the current year? Justify your response.

Short answer

Answer

1. Yes, the accrual decision will create ethical dilemma for sales manager.
2. The business entity must use6% ratefor current year.

Step-by-step solution

Definition of Warranty Expenses

Warranty expenses can be defined as the sacrifices made by the business entity in respect of the repair and maintenance of the defective product.

Ethical Dilemma

Yes, the decision made in respect of the warranty expenses will create a ethical dilemma for Bly because he is sales manager and he earn bonus depending upon the sales revenue net of warranty expenses. It will create conflict of interest and he will try to accrue less amount of the warranty expenses for getting higher compensation.

Percentage for current year

The sales manager must select the percentage that will not be too much low and to much high so that sufficient balance is maintained in the reserve created for warranty along with good amount of profit. The sales manager must calculate the percentage of warranty expenses as follow:

$$\begin{gathered} Percentageofwarrantyexpenses=\frac{Lowerrange+Upperrange}{2} \\ =\frac{10\%+3\%}{2} \\ =6.5\% \end{gathered}$$