Question

Gallardo is president of Quantym Corporation, a company whose stock is traded on a national exchange. In a meeting with investment analysts at the beginning of the year, Gallardo had predicted that the company’s earnings would grow by 20% this year. Unfortunately, sales have been less than expected for the year, and Gallardo concluded with two weeks of the end of the fiscal year that it would impossible to ultimately report an increase in earning as large as predicted unless some drastic action was taken. Accordingly, Gallardo has ordered that wherever possible, expenditures should be postponed to the new year – including canceling or postponing orders with suppliers, delaying planned maintenance and training, and cutting back on end-of-the-year advertising and travel. Additionally, Gallardo ordered the company’s controller to carefully scrutinize all costs that are currently classified as period costs and reclassify as many as possible as product costs. The company is expected to have substantial inventories of work in process and finished goods at the end of the year.

Why would reclassifying period costs as product costs increase this period’s reported earnings?
Do you believe Gallardo’s actions are ethical? Why or why not?

Answer 1

Ans:-As per Analysts’ assumption in the beginning of the Financial Year the profit of the company would grow by 20% but In the real scenario the Profit is below their expectations so they have postponed their expenditures because their sales have been less than Expected for the Year and two weeks only remained .Due to this Gallardo defined a strategy to increase their earning he has postponed and cancelled order of supplies, maintenance training,advertisement,travel expenses etc.          By this strategy he controlled all the expenses for the Year and increases the earning.

Period cost is all types of cost which related to the financial Year. All types of Direct and indirect cost come under it. Direct costs are related to manufacturing of product and indirect costs are related with sales and office like advertisements, selling, supplies, promotion etc.

Logic behind reclassifying Period cost as Product cost to increase the inventory cost which is in work in progress. on the other hand reduces their office and admin Expenses which affect the Net profit of the company and also effect the share price of the company. Product cost basically means direct cost which is directly related to product.

Do you believe Gallardo's actions are ethical? Why or why not?

Gallardo decision to postpone expenditures is questionable, this is because it is one thing to postpone expenditures due to cash bind and another to postpone expenditures in order to hit a targeted profit. Postponing these expenditures have the effect of ultimately increasing future costs and reducing future profits. If the orders to the company's suppliers are changed this may lead to a disruption in the supplier's operations. The additional costs may be passed on Gallardo and may create ill will and feelings of mistrust. Postponing maintenance on equipment is particularly questionable, the result may be breakdowns, insufficient and unsafe operations and also shortened life of the machinery of the company.

Gallardo decision to reclassify the period cost is unethical this is because, assuming that there is no intention of disclosing in the financial the reclassification the reclassification will be a violation of the principle of consistency in financial reporting and is an attempt to mislead the readers of the financial reports.