Project Earnings Manipulation: An Ethics Case Based on Agency Theory ABSTRACT: The impact of accounting information on ethical behavior has been extensively documented. Additionally, agency theory is a widely accepted behavioral perspective. Despite this, there is an absence of instructional material in the accounting education literature that ties ethical issues to an agency-theory context. The primary objective of this case is to highlight control system ethical issues using an agency-theory context. Students explore their own reactions to a prohibited but unmonitored cost allocation action. Thus, this case is positioned to fill this void in any accounting course that covers agency theory or management control systems.
ue Davies, a single mother with two school-aged children, was a project manager in Pure Marine’s Membrane and Related Equipment Group. It was a Friday afternoon late in September with Indian Summer in full force. She sat in her office considering how to account for the last $2 million of a $5 million Technical Improvement R&D expenditure that had just arrived in her internal mail for cost allocation. She had originally approved the expenditure over a year ago for Project K(3), but she was now unsure whether to charge the last $2 million to the nearly completed K(3), or to two recently started projects. Since its founding in 1948, Pure Marine had maintained industry leadership in the large-scale provision of clean water. For almost 50 years, the
company had developed membranebased and other advanced technology systems for municipal and industrial markets. The technology is used for desalination and wastewater treatment as well as the production of highly pure water. These markets currently account for about 52 percent of Pure Marine’s revenues and 37 percent of total earnings. The other two major business areas include operation or ownership/operation of water treatment facilities for Jeffrey is an Associate Professor at Boston College, Laurie is a Professor at Suffolk University, and David is an Associate Professor at the University of Western Ontario. The authors are grateful for helpful comments received from Dan Daly, Ganesh Krishnamoorthy, Sue Ravenscroft, Arnie Wright, and from the many students who have helped us pretest this case.
customers (26 percent of revenues and 43 percent of profits) and a consumer products group providing household bottled water, purification systems, and bleach and cleaning products (22 percent of revenues and 20 percent of earnings). For the last 20 years Pure Marine has been a publicly held company, and the before-tax net profit last year was about 10 percent of sales. Overall, the company has been growing steadily. Current annual targets are 20 percent growth in revenues and profits, and this year’s total revenue was about $120 million. During the past nine years, revenue grew at an average annual rate of 16 percent while earnings per share grew at an average annual rate of 30 percent. These increases kept Pure Marine at the top of a strong and steadily growing industry. While a substantial portion of Pure Marine’s recent growth has come from the supply of its own equipment in either an own-and-operate or a service mode, the membrane and related equipment business was also an important contributor to the business mix. For example, a recent boom in construction of semiconductor chip plants caused a resurgence in the company’s capital equipment business by dramatically increasing its activities in the manufacture of very large ultra-pure water systems for companies like Digital and Motorola. A typical order for Pure Marine’s Membrane and Related Equipment averaged about $5 million, and in a typical year Pure Marine received about a dozen such orders. Projects took approximately 18 months from the order to completion. Pricing was based on cost estimates prepared under the direction of project managers who were responsible for...
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