Question

FDP Company produces a variety of home security products. Gary Price, the company’s president, is concerned with the fourth-quarter market demand for the company’s products. Unless something is done in the last two months of the year, the company is likely to miss its earnings expectation of Wall Street analysts. Price still remembers when FDP’s earnings were below analysts’ expectation by two cents a share three years ago, and the company’s share price fell 19% the day earnings were announced. In a recent meeting, Price told his top management that something must be done quickly. One proposal by the marketing vice president was to give a deep discount to the company’s major customers to increase the company’s sales in the fourth quarter. The company controller pointed out that while the discount could increase sales, it may not help the bottom line; to the contrary, it could lower income. The controller said, “Since we have enough storage capacity, we might simply increase our production in the fourth quarter to increase our reported profit.”

Required

1. Gary Price is not sure how the increase in production without a corresponding increase in sales could help boost the company’s income. Explain to Price how reported income varies with respect to production level.

2. Is there an ethical concern in this situation? If so, which parties are affected? Explain.

Short answer

(1) The increase in production without a corresponding increases in sales could help boost the company’s income.

(2) Yes, whatever the probability company has shown in report is not correct so it is more likely that company will not be able to fulfil its expectations. Both the parties will be affected badly in this situation.

Step-by-step solution

Step 1:

Income under variable costing is effected by the fluctuation in the level of units sold. As a general rule when sales increases net operating income increases. Absorptioncosting income is influented by changes in unit sales and units of production.Net operating income can be increased by producing in more units even if those units are not sold.

Step 2:

Yes, there is an ethical concern in this situation by presenting the higher reported income which is not actually increased. The company can try to misrepresent the situation that is not fair according to ethical platform. If company will not practice that as per their expectation, they will be in a massive loss. The company will also be affected by this step as further when the matter will be disclosed it will affect the reputation of the company adversely.