Ethics and performance evaluation (Learning Objective 2) Costello Company has several divisions….

Ethics and performance evaluation (Learning Objective 2)

Costello Company has several divisions. The controller, Sarah James, prepares monthly segment reports for each division . Each division manager is evaluated annually, based largely on the segment margin for the manager's division . The segment margin for the division determines whether the manager receives a bonus, the amount of any bonus, and whether the division will even continue to be operated . Since operating losses reflect common fixed costs being allocated to a division, company management allows a division to show an operating loss in one or more years . However, the division is likely to be closed if its segment margin is negative for three consecutive years since management feels that the division is then a drain on the overall company's profits . The past few years have been tough years for the Small Engines division . The economy has caused sales to shrink . In addition, the production manager, Daniel Whalen, has had some personal problems and has not been focused on work . Whalen thinks his personal issues are behind him now, and he is looking forward to better results in future years-as long as his division is not discontinued due to its poor operating results in the past few years . Here is an excerpt from the segment report for the Small Engines division for the past three years :

James, the controller, is in a relationship with Whalen, the division manager of Small Engines. She wants to do whatever she can to help him with his work situation; she knows he is a good person and works hard. Once she sees the segment margin report for the Small Engines division, she realizes that there is a strong possibility that the Small Engines division will be closed due to segment margin losses over the past three years. She analyses the preliminary segment margin performance report and realizes that there is an easy way that she could help. She could move some of the direct fixed expenses listed on the Small Engine segment report into the common fixed expenses allocated to the Small Engine division. She reasons that the overall operating income for the Small Engine division will remain the same and it really isn't hurting anyone to do this. In fact, she actually feels that she is helping the company and its employees. By the simple act of shifting some of the direct fixed costs to the common fixed expenses, she will be saving people's jobs by preventing the division from being closed. There is very little chance of this shift between fixed expense categories being caught because the segment reports are hard to understand. No one in the company outside of the Accounting Department understands what is included in “Direct fixed expenses” versus “Common fixed costs.” James has used a convoluted allocation system for years, and company management has given up on understanding it and just accepts the monthly reports. Company management figures that overall, the company does well, so the hard-to-understand accounting reports are just a necessary evil.


1. Using the IMA Statement of Ethical Professional Practice as an ethical framework (see Exhibit 1-7), answer the following questions:

a. What is (are) the ethical issue(s) in this situation?

b. What are James' responsibilities as a management accountant?

2. Do you agree with James ' reasoning that no one would get hurt by her actions? Why or why not?

3. Do you agree with James ' assessment that she is actually helping the company and that this justifies her actions?

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