Case 3-34 (45 minutes) 1.

Shaving 5% off the estimated direct labor-hours in the predetermined overhead rate will result in an artificially high overhead rate which is li!ely to result in overapplied overhead for the year. "he cumulative effect of overapplying the overhead throughout the year is all recogni#ed in $ecember when the balance in the %anufacturing &verhead account is closed out to 'ost of (oods Sold. )f the balance were closed out every month or every *uarter this effect would be dissipated over the course of the year. +. "his *uestion may generate lively debate. ,here should 'ristin %adsen-s loyalties lie. )s she wor!ing for the general manager of the division or for the corporate controller. )s there anything wrong with the /'hristmas bonus0. 1ow far should 'ristin go in buc!ing her boss on a new 2ob. ,hile individuals can certainly disagree about what 'ristin should do some of the facts are indisputable. 3irst the practice of understating direct labor-hours results in artificially inflating the overhead rate. "his has the effect of inflating the cost of goods sold figures in all months prior to $ecember and overstating the costs of inventories. )n $ecember the ad2ustment for overapplied overhead provides a big boost to net operating income. "herefore the practice results in distortions in the pattern of net operating income over the year. )n addition since all of the ad2ustment is ta!en to 'ost of (oods Sold inventories are still overstated at year-end. "his means that retained earnings is also overstated. ,hile 'ristin is in an e4tremely difficult position her responsibilities under the )%5-s Statement of 6thical 7rofessional 7ractice seem to be clear. "he 'redibility standard states that management accountants have a responsibility to /disclose all relevant information that could reasonably be e4pected to influence an intended user-s understanding of the reports analyses or recommendations.0 'ristin should discuss this situation with her immediate supervisor in the controller-s office at corporate head*uarters. "his step may bring her into direct conflict with the general manager of the division so it
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would be a very difficult decision for her to ma!e.

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Case 3-34 (continued) )n the actual situation that this case is based on the corporate controller-s staff were aware of the general manager-s accounting tric!s but top management of the company supported the general manager because /he comes through with the results0 and could be relied on to hit the annual profit targets for his division. 7ersonally we would be very uncomfortable supporting a manager who will resort to deliberate distortions to achieve /results.0 )f the manager will pull tric!s in this area what else might he be doing that is *uestionable or even perhaps illegal.

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