Question

Spencer Wilkes is the marketing manager at Darby Company. Last year, Spencer recommended the company approve a capital investment project for the addition of a new product line. Spencer’s recommendation included predicted cash inflows for five years from the sales of the new product line. Darby Company has been selling the new products for almost one year. The company has a policy of conducting annual post audits on capital investments, and Spencer is concerned about the one-year post-audit because sales in the first year have been lower than he estimated. However, sales have been increasing for the last couple of months, and Spencer expects that by the end of the second year, actual sales will exceed his estimates for the first two years combined.

Spencer wants to shift some sales from the second year of the project into the first year. Doing so will make it appear that his cash flow predictions were accurate. With accurate estimates, he will be able to avoid a poor performance evaluation. Spencer has discussed his plan with a couple of key sales representatives, urging them to report sales in the current month that will not be shipped until a later month. Spencer has justified this course of action by explaining that there will be no effect on the annual financial statements because the project year does not coincide with the fiscal year––by the time the accounting year ends, the sales will have actually occurred.

Requirements

1. What is the fundamental ethical issue? Who are the affected parties?

2. If you were a sales representative at Darby Company, how would you respond to Spencer’s request? Why?

3. If you were Spencer’s manager and you discovered his plan, how would you respond?

4. Are there other courses of action Spencer could take?

Short answer

1. Fundamental ethics issues include sales transfer between the years,affecting all the stakeholders.
2. The sales representative must not follow the process requested by Spencer.
3. The manager must warn about the consequences of such an evil plan.
4. Reporting advance revenue and reporting coming sales in the notes to the financial statement.

Step-by-step solution

Definition of Unethical Activities

All those activities against the moral principle and carried out to take undue advantage are known as unethical activities.

Fundamental ethical issues

The fundamental ethical issue is that Spencer wants to shift the second year’s sales to year one to reflect good performance and avoid poor performance evaluation in the post-audit process. The parties that get affectedare:

1. Spencer.
2. Sales representative.
3. Owner of the business.

Response to Spencer’s request

Thesales representative must not proceedwith the request made by Spencerbecause it is not an ethical activity to shift the sales of the succeeding fiscal year to the current year as under accrual accounting, transactions will be recorded when it occurs. It is a type of unethical activity because it will misrepresent the financial statements of the business entity.

Response to Spencer’s plan

After discovering the plant, themanager must warn Spencerto shift the sales from succeeding to the current year. The warning must include the consequences of the unethical practices that Spencer wishes to follow.

Other courses of action

1. Spencer can report unearned sales revenue for reporting the sales that will occur in the later period. It will reflect the sales increase rate at the time of evaluation post-audit.

2. Spencer can report the future business sales in the notes to the financial statementthat will reflect the project’s profitability and also report the increase in the sales in the last two months.