Departmental Issues and Ethical Dilemmas in Eterno Strategic and environmental management accounting • Ethics • Operations management Management accounting Financial reporting Introduction The automotive industry is an industry in which the rate of change is high, with a massive number of new technologies influencing the performance of its players. In particular, there are issues related to ethics, operations management, management accounting and financial reporting. Background of the company Eterno Limited (Eterno) is a car manufacturing company operating in the United Kingdom, manufacturing vehicles mainly for the European market. The company was incorporated in 1977 and now seeks to expand its market to the United States after its recent success in Asia. The company focuses on design, manufacturing and distribution of petrol and diesel cars, with a subsidiary EA Supercars specializing in manufacturing sports cars. The company uses a traditional management model with a top-down organizational structure. Staffed with 55 management employees, Eterno has been aggressively pursuing to dominate the world's car market ever since Susan became the chief executive officer (CEO) five years ago. There are certain important issues to be highlighted in Eterno's management team as it is having difficulties in the industry. The organization chart in Figure 1 illustrates the reporting relationships between various departments in Eterno. Louis has been the general manager (GM) of Eterno for the past 10 years. He
Board of Directors CEO Legal & Secretarial General Manager Procurement Strategy Production Parts Centre Finance Sales Operating Officer Commercial Distribution Centre Quality HR. Admin & Property Special Projects Engineering EA Supercars "A subsidiary of Eterno Figure 1 Organization chart of Eterno has more experience in the industry than Susan. Susan listens to most of his advice even though his advice may sound silly sometimes, such as increasing the salary of certain departments only which had caused dissatisfaction in other departments. The production team is headed by Elly, the production manager, and she is assisted by Hassan. Steve is the supervisor in production operations while Melvin is the supply staff who has been handling Eterno's suppliers for the past seven years. Melvin has always cared about the company's relationship with the suppliers as he believes that maintaining a good rapport with the suppliers will ensure on- time supply of quality raw materials. However, his boss Elly just wants to make sure that her department's expenses are within the budget despite the fact that goods of lower prices are of low quality. In the sales department, the sales manager Tessa oversees all the sales made by the company. Neil is the newly appointed accountant in the finance department. Being new, Neil is unsure about the revenue recognition method in accounting, especially in Eterno's context. He also faces pressure from the GM as he is expected to do what is asked of him without being given the reasons behind those instructions. Lastly, Vivian is the head of the research and development department, who does not expect that an extra protocol created by her programmers would cause an ethical dilemma. Case study Production department Elly, the production manager, received a call from Melvin, the supply statt. who informed Elly that a supplier, Donata Corporation (Donatal, was
unable to supply the requested quantity of pedals in the time frame given. On top of that, Donata was increasing the cost per unit due to the current economic conditions. Elly: Then find another supplier who can cover for the shortage that will fit our budget. Melvin: But Elly, Donata has been our supplier for almost seven years. We can't just replace them like that. Besides, only Donata can supply the quality of pedals that meets our requirements. Other suppliers are incapable of providing the same quality we seek, especially at lower prices. Elly: A slight drop in quality is acceptable as long as we can keep our costs within the budget constraints. It's still within our acceptable range. Just do what I've told you. Find another supplier and cancel our contract with Donata Corporation. Melvin was dissatisfied with Elly's decision to terminate the contract with a long-time supplier. He thought that the company should have a good relationship with its suppliers to maintain quality supply on a long- term basis. Melvin recalled the problem from a few months ago which also involved the inventory. At that time, Eterno's subsidiary EA Supercars had an overcapacity of sports car accessories due to the purchases that were done in batches. The groups of workers in charge of the assembly function had focused on the processes set in assembling the cars using batches of components. The production was stopped unexpectedly due to some internal problems, which had caused the assembly area for that particular process to be cluttered. Melvin personally thought that the majority of the employees were unmotivated because of the cramped working area. It was an eyesore as the accessories were placed everywhere in the warehouse. New designs were coming up but the old accessories that were not being used anymore were still occupying the warehouse. Back then, they had excess inventory but now they were having a shortage of inventory. Something was not right with the inventory supply system. The management believed that the abundance and shortfall in the inventory were due to the inventory supply system being ineffective. Melvin agreed that attempting to close the gap of the inventory level variance between the company's current inventory holding quantity and the supplier's ability to supply was not easy. However, if the company could overcome this issue, it would achieve a significant level of quality improvement and timeliness. Melvin then decided that he would just follow Elly's orders as he did not want to lose his job. He managed to find another supplier called Alibaba Corporation to supply the materials within the budget constraints.
Elly would normally monitor the production line from her office. She would have site visits monthly or when there were problems reported by her assistant Hassan. Recently, she discovered that the assembly line had then conducted a meeting with Hassan and the assembly line supervisor Steve. Hassan: The first batch had failed to achieve the targeted quantity due to the disruption caused by the robotic system update conducted by the IT department. The processes were delayed to give way for them to do their work. Elly: Yes, I'm aware of that but it doesn't explain the next two stalled batches. As far as I know, there were no more activities that could have affected the production process. Assigning overtime was supposed to have solved the delay. Hassan: The workers refused to do overtime. We had to carry forward all the stalled production into the next batch and the excess continued until the third batch. Then, we managed to clear the balance. Steve: It's as he says, Elly. On paper, the assignment of overtime is indeed capable to cover for the pushed forward production. However, most of the workers have made plans in advance before we arranged the overtime schedule. They refused to accept last-minute overtime requests. Most of them are relying on the supervisor's announcement to update them on their current performance. It's also in my opinion that the failure of overtime arrangement is due to the lack of communication between supervisors, line leaders and the workers. Hassan: I agree with Steve. We are lacking in communication between the different lines of employees. Even I find it difficult to request daily status updates from each process. Most of the workers are unaware of their current production performance so they assume that they're doing well unless there's an announcement made by the supervisor. There's no tool available as a reference for workers to align their working attitude with the current performance. The production department's failure in achieving its desired quantity was tolerable because the number of units produced exceeded the previous month's sales. However, the value was insignificant and Eterno did not achieve the sales projection for the month. The department had also failed to achieve the desired production level due to the lack of communication about the current performance with the production line. The workers were not working efficiently and effectively as they were not aware about the performance of their own line.
Finance department Related to the problems in the production department, Eterno had failed to achieve its profit projection for the year. Louis, the GM, was worried about the shareholders' perception on the company's financial stability. Neil was recently appointed as an accountant in Eterno as the previous accountant had resigned from the company. The GM held a meeting with Tessa, the sales manager, along with Neil, to settle this issue. Louis: Due to the delays in the production department, our profit will not reach our target for this year. Do you have any suggestions to curb this outcome, Tessa? We will lose our investors' confidence if we fail to achieve their expectations. Tessa: My team has tried our best to boost our sales, Louis. We cooperate with the marketing team and launched aggressive advertising campaigns for our cars but the unstable economy has deterred many potential customers from purchasing new vehicles. Besides, the government had recently announced that it will provide a subsidy for those who buy vehicles next year, so more people are waiting to purchase a new vehicle. Louis: Then there's nothing we can do. Nevertheless, I want our financial reports to look good this year. Neil, I want you to close the sales in the year-end but pass the title of the vehicles to the buyers in January. We can also use this as a 'marketing approach' to attract customers because we're helping them to save the consumer personal property tax liability, Neil: We can't do that. Louis. The auditor will find out. There will be a cut-off issue and they will definitely make audit adjustments. Louis: Nothing's wrong here, Neil. We just pass the title later. It will not affect any accounting procedures or standards. As for the incentives given to the customers, do not recognize it in the sales account. Open a new account for incentives. This will not affect our net income and at the same time we can show that our sales are increasing. Don't worry Neil, we have not breached any accounting standards. Just follow my instructions. If the auditors find out about this matter later, we will further discuss it and explain it to them. No worries! Neil: If you say so, Louis. Louis and Neil agreed upon the changes done in recognizing Eterno's revenue to increase its profit in the way discussed. Neil was rather reluctant to do so but he was not in any position to go against Louis as he was just a new employee. Neil worried that the cut-off issue would then bring more problems when audit adjustments needed to be made. He agreed that the incentives given to the customers should be prepared separately as they
were classified as 'advertising expenses'. Without the incentives, customers would not buy Eterno's products so the incentives given were considered as a marketing strategy to push sales. The GM insisted that the accountant should prepare the financial statements using the method as discussed in order for the statements to look good in the eyes of their investors. As the company did not reach the targeted profit, the GM altered the way to have the extensive knowledge on how they were supposed to recognize the recognize the revenue. Despite the unethical act, Neil and Tessa did not revenue. Research and development (R&D) department Louis thought that the R&D department needed to be treated well as this department provided the company with more innovations for the new design and engine of the cars. In the beginning of 2014, a new type of vehicle, the X-301, had the best sales compared to other vehicles in the last two years. With the hard work of the employees in R&D, Eterno managed to increase its sales by 10% in a year's time. The following is the income statement for Eterno for three years. Eterno Ltd Statement of profit or loss for the year ended FY2012 FY2013 FY2014 £ £ Net revenues Sales of products Financing operations Total net revenues 20,028,604 1,402,766 21,431,370 18,833,706 1,321,014 20,154,720 21,038,645 1,345,799 22,384,444 (16,125,146) (869,334) (15,693,468) (864,850) (16,136,334) (899,568) Costs and expenses Cost of products sold Cost of financing operations Selling, general and administrative cost Total costs and expenses (2,131,219) (2,040,951) (2,134,778) (19,125,699) (18,599,269) (19,170,680) Operating income 2,305,671 1,555,451 3,213,764
FY2012 FY2013 4 FY2014 £ 135,061 129,644 136,099 Other income (expenses) Interest and dividend income Interest expense Net foreign exchange gain Net other income Total other income (expenses) (29,302) 32,830 (19.588) 42,536 (30,467) 35,776 8,652 147,241 56,029 208,621 12,431 153,839 2,452,912 1,764,072 3,367,603 (736,823) Income before income taxes and equity in earnings of affiliated companies Provision for income taxes Equity in earnings of affiliated companies Net income (525,244) (758,968) 267,728 258,002 267,755 1,983,817 1,496,830 2,876,390 He then proposed the idea to increase the employee benefits for the R&D employees to the CEO Susan, who was more focused on gaining profit for the company. So, she approved Louis's idea about increasing the salary for the staff in the R&D department. In the staff general meeting, Louis said, 'In the following month, all staff will receive an increment in their salary by 5% for helping our company gain more revenue and also enhancing the company's reputation, but there will be an extra increment of 5% for the R&D department as it had provided lots of innovative ideas that increased the sales of different types of vehicles. The CEO has approved this and she said it would be an incentive for those working on research and development." All the managers and directors were shocked when they heard this and they did not agree with Louis's decision. They found it unfair because the increase in revenue was not solely due to the R&D department. Other departments had put in a lot of effort as well to ensure that the company was prospering. During break time, Marina, the manager of the management team, was not satisfied so she voiced out, 'The CEO is selfish to focus only on the department that she thinks will generate revenue for the company. What about us? Our management team had word so hard to support R&D but we received only a small amount of
increment in our salary. This isn't fair for us. I think we shouldn't work so hard for the company as it places more focus on other departments, and Elly also chipped in that the production department had turned the innovations from the R&D department into finished goods. Without her department, the company would have nothing to sell to the customers. She complained that the R&D employees just had to generate ideas in their to work very hard in the plants to ensure that the quality and quantity of didn't appreciate our hard work at all.' minds and they could get inspiration anywhere, but her employees needed the production reached the target set. The GM increased the benefits of the R&D employees without any strong reason, which the employees from other departments felt unfair. Despite the complaints from different teams, Susan and Louis still focused on their main objective which was to maximize the company's profit by empowering innovations in car and engine design. Susan had a rising concern regarding the emission systems. She asked Louis to come over to her office to discuss it. She said, 'For the past decade, car manufacturing companies had been pouring millions into the enhancement and production of diesel vehicles due to the endorsement of diesel as a more fuel-efficient substance than petrol, until scientists retracted that statement with new research. Some countries even made their emissions regulation more stringent for diesel vehicles. Should we do something about it, Louis? This issue had caused Eterno to face some problems as its diesel cars could not perform as well as they should when their internal emissions control systems were running. Even with the current emission control system, the emissions were still above the regulation threshold of certain countries, such as the United States. The management, however, was keen on dominating the American market, which was well-known to be very strict in its emissions regulation compared to the EU. This objective was quite a concern for the R&D department as it was still in the process of developing a system that controlled the level of emissions better. This situation was discussed between Vivian, who was the manager of R&D department, and Louis. Vivian: We haven't been able to upgrade the system to comply with the American regulations yet. We are already in the midst of it; hopefully by next year, we could get it done. Louis: Then make the cars pass the test. You can do whatever upgrades you need after we get the green light from the testing committee. The management wants us to get the cars on the streets, and as far as I am concerned, we just need to follow this instruction. Vivian: I think we could do something like that. We have an additional protocol where we can tweak the current system to restrict the emissions down to the levels needed to pass the test if we
Louis: programmed it in controlled lab conditions, but it will revert back to its original settings if the cars are used on the streets. If the cars were to be sold in the American market and they discover this after the cars are released, we'd be in deep trouble. Like I said, I just want the cars on the streets. Who would actually check the emission levels after the cars are on the road? You're thinking too much, Vivian! Just do whatever you need to do. Vivian was baffled as to whether to proceed with her plan as the extra protocol in the system was actually one that her programmers had created during their spare time. Little did they expect that the extra protocol would be used, although it was tested thoroughly to meet their satisfaction. However, the GM was very insistent on reaching the target and he might override her authority to make the decision. After all, the testing committee was not going to test the cars out on the streets. The upper management's target was ridiculous, and thus created an ethical dilemma of following instructions despite the technological disadvantage. Application Questions 1 Discuss the issues that arose in the production department. Suggest the best solution that could help the management team to solve them. You may use your own assumptions to support your answer. 2. How important is proper revenue recognition in a company? How should cash incentive in Eterno be treated? Do you agree with Eterno's ways of recognizing its revenue? Explain your answer. 3 Some of the management team members feel that the decision made by the CEO and the general manager is unfair to the What is the best way to make sure that every team member agrees with the decision made by the general manager? (You can give an example of a new trending action (if any) or a budding action that is currently being taken.) 4 What are the possible implications of the fraud being found out by the testing committee? What options does Vivian have?
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