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Ethical Dilemma in Sales Compensation Scheme

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Added on  2020/11/02

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AI Summary
The case revolves around Roger's dilemma of reporting the unethical behavior of his colleagues in achieving their bonuses. He needs to weigh the importance of maintaining his friendship with Sue, who is also involved in this scheme, against his professional principles and duty to maximize shareholder value. The scenario presents three possible courses of action for Roger: keeping quiet, passing on the information to senior management, or revealing it surreptitiously through a benchmarking exercise.

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Module 9- Budgeting
Review Question Page 492
Question 1
Discuss the stages and parties typically involved in the budget process.
Budgets serve two primary purposes: as a form of feedforward control (or planning) and in
providing feedback control (or performance monitoring, evaluation and corrective action).
Thus, most organisations engage in some form of budgetary process. Senior and middle-
level managers typically have some form of budget responsibility whether it be over cost,
revenues, profits and/or assets.
Whilst the extent and complexity of a budget process is largely influenced by the type and
size of the organisation, there are stages that are common to most. The following stages are
encountered in most budget processes:
Setting of budget-period goals consistent with the organisation’s strategy.
As the budget is the short-term expression of an organisation’s strategies, the budget
must be congruent with those strategies. Thus, assumptions about the organisation’s
business environment and organisational capabilities used in the preparation of past
budgets must be reviewed and updated where required.
Organisational stakeholders involved: Senior management
Evaluate past organisational performance for the purposes of identifying
areas for improvement and/or future growth
The identification and evaluation of gaps between planned and actual performance,
provides opportunities for taking action in a new budget period. Attention may focus on
addressing and resolving operational bottlenecks that inhibit the growth in
organisational revenue, ensuring that the drivers of organisational costs are well
understood and managed and/or that sufficient funding is secured so as to capitalise on
future growth opportunities as they emerge and are developed.
Organisational stakeholders involved: Senior and middle-level management
Translation of budgetary aspirations into operational terms
For budgetary aspirations to be realised, they must be translated into an operational form
and have functional responsibilities assigned and interrelationships between functions
identified and described. Proposed operational decisions carry with them implications
about the allocation of resources among organisational functions and define the nature
and extent of functional relationships.
Organisational stakeholders involved: Senior and middle-level management
Develop the budget
Based on the assumption that the organisation has previously used a budget package,
budget instructions will need to be refreshed along with an updating of current year-to-
date budget numbers, such as income and costs. Where past performance issues have
been identified (e.g. operational bottlenecks, ineffective cost management or funding
constraints), the budget package will indicate how they are to be addressed in the
coming budget period(s).
As the generation of revenue is the trigger for most organisational activities, a forecast of
revenue needs to be developed, vetted and confirmed as a feasible target. Once a sales
forecast is agreed upon, it is then possible for managers to develop their own budgets.

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Apart from developing operational (or annual budget) numbers relevant to their area of
responsibility, managers may also need to bid for funds to use for capital-related
purposes (e.g. acquisition of plant and equipment).
Once departmental budgets have been submitted, they will be checked for errors and their
consistency with organisational goals and strategic intentions confirmed. Where
required, further revisions to individual departmental budgets may be necessary before
they are incorporated into the master budget.
Once the master budget has been prepared, it will need to be reviewed by senior
management and eventually approved. However, there may be a series of budget
iterations as senior and middle-level managers negotiate over the contents of the master
and individual departmental budgets before they are approved.
Organisational stakeholders involved: Senior and middle-level managers of functional
areas such as sales and marketing, procurement and warehousing, production,
accounting and finance and so on.
Executing the approved budget
Once the budget has been finalised, its contents need to be communicated to those
managers who possess some form of budget responsibility. Furthermore, the budget will
need to be uploaded to the accounting information system (AIS). This facilitates the
comparison of actual to budget performance and will generate reports for the attention
and action of managers who hold budget responsibilities.
Organisational stakeholders involved: Senior and middle-level managers of functional
areas such as sales and marketing, procurement and warehousing, production,
accounting and finance and so on.
Question 2
Explain how budgets mean different things to different people within an organisation, giving
reasons.
Often budgets will mean different things to different people in an organisation. For example,
management may introduce budgets primarily for the purpose of enhancing organisational
planning. However, the introduction of the budget may be viewed by negatively by lower-
level managers who fear that the budgetary controls imposed on them will limit their
autonomy and subject them to greater levels of scrutiny and accountability.
Question 4
Discuss the interrelationships between the sales budget and the production budget in a
manufacturing organisation.
In a manufacturing firm, it is extremely important that the linkages between the sales and the
production functions are well coordinated. The main reason for this is that the production
cycle, being the time taken to produce goods for sale, can be relatively long. For example, if
a manufacturing firm was to amend its sales budget halfway through a budget period,
production personnel need to know this so they can plan and take such actions as to ensure
the products are available for sale as per the amended sales plan. This may involve ordering
additional raw materials inventories, amending production schedules and possibly
introducing overtime or shift working, all of which may take time to plan for and then
actually implement.
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Problem 10
The owner of a business that sells fitness equipment for use in homes has requested a forecast
of sales from her two salespeople for the next three months. She is trying to prepare a cash
budget for the first quarter of next financial year. The two sales representatives provide the
following sales forecasts:
Joe’s estimates $ Debbie’s estimates $
July 100000 90000
August 150000 200000
September 170000 300000
October 160000 400000
The following details are available:
Inventory costs average 70% of sales. Purchases are enough to cover the next month’s
sales and all purchases are paid in the month of purchase.
All sales are on account. Most customers pay the total within one month of the sale.
Accounts receivable as at 30 June are forecast to be $80000.
Fixed expenses are $30000 per month and variable expenses are 1% of sales. All
operating expenses are paid in the month in which they are incurred. ASSUME BOTH
JOE AND DEBBIE HAVE THESE EXPENSES EACH MONTH.
The company is expected to have cash in bank of $5000 as at 1 July. The owner wants
a minimum balance of cash on hand of $5000 at the end of every month commencing
from 1 July.
1 Joe and Debbie’s cash budgets.
a Cash budgets
Cash budget for July
to September
Joe’s estimates
July August September
Cash inflows
Receivables collections
June credit sales $80 000
July credit sales $100 000
August credit sales $150 000
Cash outflows
Cost of inventory purchased
Purchases for August’s
sales:
$150 000 x 70% ($105 000)
Purchases for September’s
sales:
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$170 000 x 70% ($119 000)
Purchases for October’s
sales:
$160 000 x 70% ($112 000)
Operating expenses
Fixed operating expenses ($30 000) ($30 000) ($30 000)
Variable operating expenses:
July variable expenses
$100 000 x 1% ($1 000)
August variable expenses
$150 000 x 1% ($1 500)
September variable
expenses
$170 000 x 1% ($1 700)
Total cash outflows ($136 000) ($150 500) ($143 700)
Net cash flow ($56 000) ($50 500) $6 300
Cash balance brought
forward
$5 000 $5000 5000
borrowing 56000 50500 0
Cash balance carried forward 5000 5000 5000
Cash budget for July to September
Debbie’s estimates
July August September
Cash inflows
Receivables collections
June credit sales $80 000
July credit sales $90 000
August credit sales $200 000
Cash outflows
Cost of inventory purchased
Purchases for August’s sales:
$200 000 x 70% ($140 000)
Purchases for September’s sales:
$300 000 x 70% ($210 000)

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Purchases for October’s sales:
$400 000 x 70% ($280 000)
Operating expenses
Fixed operating expenses ($30 000) ($30 000) ($30 000)
Variable operating expenses:
July variable expenses
$90 000 x 1% ($900)
August variable expenses
$200 000 x 1% ($2 000)
September variable expenses
$300 000 x 1% ($3 000)
Total cash outflows ($170 900) ($242 000) ($313 000)
Net cash flow ($90 900) ($152 000) ($113 000)
Cash balance brought forward $5 000 5000 5000
Borrowing 90900 152000 113000
Cash balance carried forward 5000 5000 5000
In order to maintain a cash balance of $5 000 at the end of each
month, the business will need to borrow the following amounts.
a As the variations in the two estimates given by the two sales
representatives are significant, it would be recommended that further sales
estimates be obtained. The business will need to arrange a loan if the
minimum cash balance is to be maintained at $5 000. The size of the loan
depends on which estimates of sales are used. Advise the owner to seek the cheapest
source of finance. The use of a bank overdraft may be necessary in view of the
widely divergent cash flow projections.
Joe’s cash budget Debbie’s estimates
Month Before
financing
Borrow Before
financing
Borrow
July ($51 000) $56 000 $85 900 $90 900
August ($101 500) ($106 500) $237 900 $242 900
September ($95 200) ($100 200) $350 900 $355 900
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Problem 12
Borough Equipment Ltd produces two products, A and B, for sales to electrical wholesalers.
The following information relates to the six months ending 31 December:
Product Budgeted
Sales
Price per
unit ($)
Budgeted
Inventory
(units)
Budgeted
Inventory
(Units)
1 July 31 December
A 16200 14.35 5100 8100
B 11800 12.20 2600 6600
Components brought in and used in manufacture:
Component Amount used per unit of
product
Price Expected
Inventory 1
July (units)
Expected
Inventory 31
December
(units)
A B
X 5 3 $0.70 38000 46000
Y 2 4 $0.25 13500 19500
Labour:
Product Hours per unit Rate per hour ($)
A 0.50 $18.00
B 0.20 $20.00
overheads for the six months are expected to be $25000. The company uses a variable costing
system and treats overheads as a period cost.
a. Prepare the following:
i sales budget
ii production budget
iii purchases budget in terms of components
iv purchases budget in dollars
v total labour hours and cost for the period
vi contribution per unit
vii profit or loss for the period
b. Comment on the usefulness of the budgets for planning, decision making and control.
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Borough Equipment Ltd.
a i Sales
budget.
Product A Product B Total revenue
Sales units 16 200 11 800
Price per unit $14.35 $12.20
Total sales revenue $232 470 $143 960 $376 430
ii Production budget
Product A Product B
Budgeted sales 16 200 11 800
Plus: desired inventory, 31 December 8 100 6 600
Total inventory required 24 300 18 400
Less: estimated inventory, 1 May 5 100 2 600
Total units to be produced 19 200 5 800
iii
Purchases budget in terms of components and
iv Purchases budget in dollars.
ii The total labour hours and cost for the period.
Product A Product B
Direct labour hours (DLH)
Component X Component Y
Components required for production
Component X
Product A: 19 200 x 5 96 000
Product B: 15 800 x 3 47 400
Component Y
Product A: 19 200 x 2 38 400
Product B: 15 800 x 4 63 200
Total for production 143 400 101 600
Plus: closing inventory 46 000 19 500
Total required 189 400 121 100
Less: opening inventory (38 000) (13 500)
Purchases required in units 151 400 107 600
Cost price per unit $0.70 $0.25
Total purchases costs $105 980 $26 900

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required for production
Units produced 19 200 15 800
DLH per unit 0.50 DLH 0.20 DLH
Total DLH 9 600 DLH 3 160 DLH
Rate per DLH $18.00 $20.00
Total direct labour costs $172 800 $63 200
Total direct labour cost $236 000
iii Contribution per unit.
Product A Product B
Contribution margin per unit
Direct material costs per unit
Component X
Product A: $0.70 x 5 $3.50
Product B: $0.70 x 3 $2.10
Component Y
Product A: $0.25 x 2 $0.50
Product B: $0.25 x 4 $1.00
Total direct materials $4.00 $3.10
Direct labour costs per unit
Product A: $18.00 x 0.50 $9.00
Product B: $20.00 x 0.20 $4.00
Total variable costs $13.00 $7.10
Selling price per unit $14.35 $12.20
Contribution margin per unit $1.35 $5.10
v The profit and loss for the period:
Product
A
Product B Total
Sales units 16 200 11 800
Contribution margin per unit $1.35 $5.10
Total contribution margin $21 870 $60 180 $82 050
Less: overheads $25 000
Net profit $57 050
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b How useful are these budgets for planning, decision making and control?
Planning:
All those responsible for functions within the company must clearly
coordinate their individual budgets with others. The budgets prepared for
Borough Equipment Ltd illustrate the importance of coordination between
these functions. For example, those responsible for the labour budget will
know the hours required for the forthcoming period and can plan to ensure
this requirement is met by having the right number of employees with the
requisite skills available.
These budgets will act as a medium to communicate the short-term
objectives of the company to management and operating personnel.
The budgets represent targets which responsible personnel can work to
during the period and possibly also provide a means to motivate personnel.
Decision making:
The functional budgets give management the opportunity to make
decisions within the defined objectives of the company.
From the production of these budgets, it may be felt that certain aspects of
the budgets need to be amended before they become operational. The
budget in this context provides management with the opportunity to
examine the overall effect of operating decisions. For example, operating
decisions regarding the range of products to be made and sold would
normally be made prior to the completion of the functional and master
budgets. But these decisions, when considered as a whole within the
budgeting framework, may be reconsidered and amendments made as
required to budget variables.
Control:
The budget may be used as a source for the control of authorising of
expenditure. The fact that the total expenditure for components X and Y is
shown in the budget for the forthcoming six-month period implies this level
of expenditure has been endorsed by senior management and requires no
further authorisation from them.
These budgets provide a basis for responsibility accounting.
Budgets can also act as a basis for comparing actual performance with a
plan, and this comparison can then lead to identification of variances from
the plan, which may initiate management action so as to ensure that in
future periods such deviations do not occur.
Ethics Case Study 1
Jetco Ltd manufactures and sells Tryus, an automatic vacuum cleaner for swimming
pools. Jetco employs 10 salespeople and pays them a commission of $50 for each Tyrus
they sell. In addition, if they meet the annual budgeted sales figure of 1000 units, they
receive an annual bonus of $10000.
Sue Clean is one of the sales staff and a close friend of Roger Pool, the accountant for
Jetco. One day over lunch, Sue confides in Roger about a problem that is hurting
Jetco’s profits. She explains that the sales target of 1000 is quite easy for the sales staff
to achieve. Once achieved, there is no further financial incentive to increase sales in that
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year as the bonus is fixed at $10000. Therefore, many sales staff commit customers to
buy at the beginning of the following year, which may mean a delay on the delivery of
the vacuum cleaners of four to eight weeks. This means that these sales are recorded
next year and the salesperson is well on the way to achieving next year’s target.
Discuss the problems for Jetco as a result of the strategies of the salespeople.
what Roger should do with this information. Should he tell management or keep it
confidential as Sue requested? If management discovered that he knew of this practice
and did not say anything, he could lose his job. However, if he does say something then
Sue could lose her job, and Roger could lose a friend.
1 Jetco Ltd.
a Problems for Jetco:
The strategies of sales staff help them to achieve their $10 000 bonus but
do not maximise Jetco’s profits. The unit commission rate does not
provide sufficient incentives to seek sales above the minimum bonus
triggering point of 1000 units.
The strategies also delay (as well as reduce) cash receipts from customers,
which may cause short-term liquidity problems for Jetco.
b What should Roger do?
Firstly, Roger needs to identify who are the stakeholders affected by
Jetco’s current bonus compensation scheme and the strategies of sales
staff to game it. The key stakeholders would include:
Sue Clean
Other sales staff
Jetco shareholders.
Secondly, Roger needs to assess the significance of the problem and identify
strategies and actions that he can take. What to do about the information
on sales staff strategies? Another way to look at the case is to ask how can
the reward system be redesigned so that it maximises shareholder value?
Values and principles
Professional principles at issue here include integrity (APES 110, 110),
objectivity (APES 110, 120), and professional competence and due care
(APES 110, 130). These, combined with a commensurate duty to maximise
shareholder value, imply that Roger should reveal what he knows so that
the reward system can be redesigned.
In contrast, Roger needs to consider his friendship with Sue (i.e.
loyalty), the principle of confidentiality and whether there would be an
adverse financial or morale impact on all sales staff (i.e. a duty to avoid
harm to others).
Three possible courses of action
Action one: do not report the information to others.
Action two: pass on the information to the senior management of Jetco.
Action three: attempt to reveal the information surreptitiously (e.g. Roger

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could suggest to management that it might be time to conduct some sort
of benchmarking exercise, perhaps as part of next year’s budget
preparation, in which performance, including annual sales results and
sales salaries and bonuses, is reviewed).
Evaluation
Action one: do not report the information to others.
Maintains Sue’s friendship and confidentiality but not in keeping with the
other ethical principles or shareholders’ interests.
While the probability of this happening might be low, the strategy used by
sales staff to achieve the annual cash bonus could be discovered. If so
discovered, as Roger has prior knowledge of the strategy employed by
sales staff, he could lose his job.
Action two: pass on the information to the senior management of Jetco.
Whilst this action is in keeping with other ethical principles and
shareholders’ interests, Roger will lose Sue’s friendship, breach her
confidentiality and she could even lose her job.
Depending upon management’s reaction to the information, there could be
morale or other problems with the sales staff if they are not consulted on
any changes to the reward system.
Action three: attempt to reveal the information surreptitiously.
By passing on the information surreptitiously it may appear to Sue and the
other sales staff that any changes resulted from senior management
action rather than from any information that might have been supplied
by Roger.
A formal review of budget projections and policies as part of some
benchmarking exercise may provide the opportunity for all parties to be
involved and to be consulted about any changes.
However, there is still a risk that Sue may think that Roger
breached her confidence, and this could threaten their friendship.
Choose a plan of action
Take a poll of the class but emphasise that students present a plan of action and
that they properly justify that plan by reference to ethical principles and
consequences. When dealing with questions of ethical behaviour, often it is
helpful to ask students if they would be comfortable in having their actions
publicly revealed on television or in a court of law.
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