Chapter 4, Problem 4.55ACT

Ethics involved with ABC and hazardous waste costs (Learning Objectives 2 & 3)

ETHICS

Sparkle Unlimited is a costume jewelry manufacturer located in the United States that uses electroplating. Electroplating is a process that involves applying a decorative metal coating to a base metal. The electroplating solution, or the water that is used in this process, becomes dirty over time and needs to be replaced. This used solution for electroplating is referred to as ‘‘spent” solution.

The spent solution contains dissolved metals such as gold, silver, platinum, copper, and other metals. Cyanide can also be present in the spent solution. Because of this content, spent solution is considered to be hazardous waste. This waste is more expensive to dispose of than regular waste.

Currently, Sparkle is using a traditional, volume-based costing system for its jewelry. Total manufacturing overhead for the period is allocated to the jewelry based on machine hours used.

Recently hired, Jacob is the controller for Sparkle. He previously worked at a manufacturer that produced custom furniture. At this prior job, he implemented an activity- based costing system that helped the company to determine the profitability of different product lines. He has been learning about Sparkle’s operations and thinks activity-based costing might be a good tool for Sparkle’s management to use to help to manage its operations.

Jacob’s good friend, Michelle, is the division manager for the Silver line of jewelry at Sparkle. She runs an efficient production line and has earned bonuses for each of the past several years based on her division’s productivity and profitability. Division managers are evaluated based on profits generated by their divisions as calculated by the internal reporting system.

If activity-based costing is used to allocate costs and hazardous waste costs are allocated to the products that generate spent solutions, the calculated internal profit from the Silver product line will decrease significantly. This decrease in profitability is because the cost of handling the spent solution is quite high, and this cost would be directly assigned to the Silver line if activity-based costing were to be used.

Michelle takes Jacob out to lunch at an expensive restaurant and steers the conversation toward the upcoming activity-based costing implementation. She is concerned that her division’s profits will decrease due to the spent-solution costs charged to her division. Michelle asks Jacob if he can reduce the amount of hazardous waste costs allocated to her line.

Jacob values the working relationship he has with Michelle. She is one of the people who has input on his evaluation when it comes time for raises and promotions. He wants to keep her happy.

As a result, Jacob does not set up any cost pool for hazardous waste-disposal costs. Since the hazardous waste cost has always been part of the manufacturing process, he will continue to bury it in the other cost pools. His reasoning is that the activity-based costing system with hazardous waste-removal cost buried is still better than the traditional cost system; other costs are properly allocated and the costs are much more accurate than under the old system. He feels that no one is getting hurt. Since the activity-based costing cannot be used for external reporting, Jacob feels that what he is doing is not illegal.

Requirements

Using the IMA Statement of Ethical Professional Practice (Exhibit 1-7) as an ethical framework, answer the following questions:

1. 1. What is(are) the ethical issue(s) in this situation?
2. 2. Activity-based costing cannot be used for external financial reporting. Does this fact influence your analysis of whether Jacob has violated any ethical principles? Why or why not?
3. 3. Do you agree that no one is hurt by the burying of the hazardous waste costs into general cost pools? Explain.
4. 4. What are Jacob’s responsibilities as a management accountant? What should he do now?