Textbook Problem

Budgetary Performance, Rewards, Ethical Behavior

Linda Ellis, division manager, is evaluated and rewarded on the basis of budgetary performance. Linda, her assistants, and the plant managers are all eligible to receive a bonus if actual divisional profits are between budgeted profits and 120% of budgeted profits. The bonuses are based on a fixed percentage of actual profits. Profits above 120% of budgeted profits earn a bonus at the 120% level (in other words, there is an upper limit on possible bonus payments). If the actual profits are less than budgeted profits, no bonuses are awarded. Consider the following actions taken by Linda:

1. a. Linda tends to overestimate expenses and underestimate revenues. This approach facilitates the ability of the division to attain budgeted profits. Linda believes that the action is justified because it increases the likelihood of receiving bonuses and helps to keep the morale of the managers high.
2. b. Suppose that toward the end of the fiscal year, Linda saw that the division would not achieve budgeted profits. Accordingly, she instructed the sales department to defer the closing of a number of sales agreements to the following fiscal year. She also decided to write off some inventory that was nearly worthless. Deferring revenues to next year and writing off the inventory in a no-bonus year increased the chances of a bonus for next year.
3. c. Assume that toward the end of the year, Linda saw that actual profits would likely exceed the 120% limit and that she took actions similar to those described in Item b.

Required:

1. 1. Comment on the ethics of Linda’s behavior. Are her actions right or wrong? What role does the company play in encouraging her actions?
2. 2. Suppose that you are the marketing manager for the division, and you receive instructions to defer the closing of sales until the next fiscal year. What would you do?
3. 3. Suppose that you are a plant manager, and you know that your budget has been padded by the division manager. Further, suppose that the padding is common knowledge among the plant managers, who support it because it increases the ability to achieve the budget and receive a bonus. What would you do?
4. 4. Suppose that you are the division controller, and you receive instructions from the division manager to accelerate the recognition of some expenses that legitimately belong to a future period. What would you do?