Question

Cameron Bly is a sales manager for an automobile dealership. He ears a bonus each year based on revenue from the number of autos sold in the year less related warranty expenses. Actual warranty expenses have varied over the prior 10 years from a low of 3% of an automobile's selling price to a high of 10%. In the past, Bly has tended to estimate warranty expenses on the high end to be conservative. He must work with the dealership's accountant at year-end to arrive at the warranty expense accrual for cars sold each year. Required: • Does the warranty accrual decision create any ethical dilemma for Bly? . Because warranty expenses vary, what percent do you think Bly should choose for the current year? Justify your response.

Answer 1

Ans:-

1) Ethics are beliefs that distinguish right from wrong. They are accepted standards of good and bad behavior. Since the goal of accounting is to provide useful information for decision-making, such information must be trusted. Therefore,ethics is very important in Accounting.

When we analyze whether there is any ethical dilemma in the case of Bly, we shall follow the three steps - identifying ethical concern, analyzing option and making ethical decision.

In this case, the ethical concern is that varying the estimated warranty expense would affect the amount of bonus Bly gets, as it is based on the Company revenue earned by selling autos in the year less the related warranty expenses. This causes an ethical dilemma for Bly when choosing the appropriate warranty expense accrual percentage, in which such decision would ultimately affect his income.

Before analyzing the options of Bly, we shall first understand how to calculate the warranty expense so that we can know more on how varying the percentage in estimating will affect Bly’s income.

Warranty expense this year = Estimated warranty liabilities this year X Percentage estimated

There are two options for Bly;

1. the first one is to fulfill his self-interest by choosing the least percentage over the prior 10 years (3%) to estimate the expense in order to maximize the bonus he receives.
2. Another option is to follow the Conservatism Principle by choosing the highest percentage over the prior 10 years (10%) to estimate the expense, in which would reduce the amount of bonus he earns to the minimum. It is therefore obvious that the ethical decision for Bly is to follow the Conservatism Principle and estimate the warranty expenses on the high end (10%).

2) Ans:-

Low warranty expense =3%

High warranty expense = 10 %

Here company cannot consider higher percentage and lower percentage for current year warranty liability. Therefore, better to consider average percentage as warranty liability for the year.

Average Percentage = 3% + 10% / 2 = 6.5%