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Ethics Case 8-7
Elizabeth A. West
Liberty University
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In 2012 the Moncrief Company purchased from Jim Lester the
right to be the sole distributor in the western states of a
product called Zelenex. In payment, Moncrief agreed to pay Lester
20% of the gross profit recognized from the sale of Zelenex in
2013.
Moncrief uses a periodic inventory system and the LIFO
inventory method. Late in 2013, the following information is
available concerning the inventory of Zelenex:
Beginning Inventory 1/1/13 (10,000 Units @ $30) $300,000
Purchases (40,000 Units @ $30) $1,200,000
Sales (35,000 Units @ $60) $2,100,000
By the end of the year, the purchase price of Zelenex had
risen to $40 per unit. On December 28, 2013, three days before
year-end, Moncrief is in a position to purchase 20,000 additional
units of Zelenex at the $40 per unit price. Due to the increase
in purchase price, Moncrief will increase the selling price in
2014 to $80 per unit. Inventory on hand before the purchase,
15,000 units, is sufficient to meet the next six months' sales
and the company does not anticipate any significant changes in
purchase price during 2014.
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Requirement 1: Determine the effect of the purchase of the
additional 20,000 units on the 2013 gross profit from the sale of
Zelenex and the payment due to Jim Lester.
Costs of goods sold without the purchase of additional units
Sales (35,000 @ $60) $2,100,000
Costs of goods sold (35,000 x $30) ($1,050,000)
Gross Profit $1,050,000
Amount due to Jim Lester ($1,050,000 x 20%) = $210,000
Costs of goods sold with the purchase of additional units
Sales (35,000 @ $60) $2,100,000
Costs of goods sold (20,000 x $40)
(15,000 x $30) ($1,250,000)
Gross Profit $850,000
Amount due to Jim Lester ($850,000 x 20%) = $170,000
The amount Moncrief Company would owe to Jim Lester without
the additional units being purchased is $210,000. Due to their
use of the LIFO inventory method, the amount they would owe to
Jim Lester with the additional units being purchased is $170,000.
Therefore, the effect of Moncrief Company making the purchase of
the additional 20,000 units would be a loss of $40,000 for Jim
Lester.
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Requirement 2: Discuss the ethical dilemma Moncrief faces in
determining whether or not the additional units should be
purchased.
Moncrief Company has the opportunity to purchase additional
units in 2013 for $40 per unit. However, it does not appear they
will save any money by purchasing these units in 2013 as opposed
to 2014 as they do “not anticipate any significant changes in
purchase price in 2014” and they have enough inventory on hand
already for the first half of 2014. Therefore, the ethical
dilemma they have when considering this purchase is that it would
solely be done in order to pay Jim Lester $40,000 less per their
agreement with him. It would also affect the company’s profit for
both 2013 and 2014. It would reduction of profit in 2013 and an
increase in profit in 2014 which really should have been part of
the 2013 profit. This is considered profit manipulation.
According to the IRS, taxpayers “must use a system that clearly
reflects your income and expenses” and choosing to purchase
additional units in 2013 would not be in good faith with this
requirement. (www.irs.gov) This manipulation would have an effect
on investors, taxes, and the money due to Jim Lester.
Jim Lester made this agreement with Moncrief Company in good
faith and it would be in bad faith for the Company to
intentionally manipulate the profit in 2013 in order to pay Jim
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Lester less money under that agreement. The Bible tells us not to
be dishonest in our business dealings. “Ye shall not steal,
neither deal falsely, neither lie one to another.” (Leviticus
19:11 King James Version) The Moncrief Company would be both
dishonest and unethical with Jim Lester, their investors, and the
government if they chose to purchase additional units in the end
of 2013 to manipulate their profits in 2013.
References
