In looking over the past several years of quarterly earnings reports at the Home Security Division, she noticed that the first-quarter earnings were always poor, the second-quarter earnings were slightly better, the third-quarter earnings were again slightly better, and the fourth quarter always ended with a spectacular performance in which the Home Security Division managed to meet or exceed its target profit for the year. She also was concerned to find letters from the company’s external auditors to top management warning about an unusual use of standard costs at the Home Security Division.
When Ms. Cummins ran across these letters, she asked the assistant controller, Gary Farber, if he knew what was going on at the Home Security Division. Gary said that it was common knowledge in the company that the vice president in charge of the Home Security Division, Preston Lansing, had rigged the standards at his division in order to produce the same quarterly earnings pattern every year. According to company policy, variances are taken directly to the income statement as an adjustment to cost of goods sold.
Favorable variances have the effect of increasing net operating income, and unfavorable variances have the effect of decreasing net operating income. Lansing had rigged the standards so that there were always large favorable variances. Company policy was a little vague about when these variances have to be reported on the divisional income statements. While the intent was clearly to recognize variances on the income statement in the period in which they arise, nothing in the company’s accounting manuals actually explicitly required this.
So for many years, Lansing had followed a practice of saving up the favorable variances and using them to create a nice smooth pattern of earnings growth in the first three quarters, followed by a big “Christmas present” of an extremely good fourth quarter. (Financial reporting regulations forbid carrying variances forward from one year to the next on the annual audited financial statements, so all of the variances must appear on the divisional income statement by the end of the year. ) Ms. Cummins was concerned about these indings and attempted to bring up the subject with the president of Merced Home Products but was told that “we all know what Lansing’s doing, but as long as he continues to turn in such good reports, don’t bother him. ” When Ms. Cummins asked if the board of directors was aware of the situation, the president somewhat testily replied, “Of course they are aware. ” Required: * 1. How did Preston Lansing probably “rig” the standard costs—are the standards set too high or too low? Explain. * 2. Should Preston Lansing be permitted to continue his practice of managing reported earnings? 3. What should Stacy Cummins do in this situation? Accounting queston how to rig standard cost for favorable variances? Here is my question, A VP of a company is rigging standard cost each year to show a large favorable variance. How does he do that? In the first quarter earnings are poor, a little better in second and third quarter and really great in the fourth quarter. How is he doing this? * 3 years ago * Report Abuse Additional Details the vice president had rigged the standards at his division in order to produce the same quarterly earnings pattern every year.
According to company policy, variances are taken directly to the income statement as an adjustment to cost of goods sold. Lansing had rigged the standards so that there were always large favorable variances. How did Preston Lansing probably “rig” the standard costs – are the standards set too high to too low? Explain. Thanks for any help.. this is all the information I have. 3 years ago by Daniel Member since: June 19, 2009 Total points: 426 (Level 2) * Add Contact * Block Best Answer – Chosen by Voters The standards are set too high.
When the products are run at a lower cost than the standard, then this produces a favorable variance. The COGS and variance should net to the correct cost though (this is the reason the system creates the variance). The bigger problem here is that any inventory is likely to be overvalued because of wrong standards. Finished goods inventory is valued at the standard cost. So if there is a lot of inventory at an inflated cost, then the COGS is being reduced on the income statement too much because of this. If the inventory were to be revalued at it’s correct standard cost, there would be a large expense to the income statement.
I would say he has been building inventory, more and more each quarter. Source(s): www. cost-accounting-info. com Standards Rigging Standards Case 10-27 /Rigging Standards 1) How did Preston Lansing Probably ‘rig’ the standard costs-are the standards set too high or too low? Explain The standards are set too high. When the products are run at a lower cost than the standard, then this produces a favorable variance. The cost of goods sold and variance should net to the correct cost though and this is the reason the system creates the variance.
Lansing set a loose standard which the standard quantities and standard price are high, flowing this situation favorable variances will ordinarily result from operations. When the standard cost set artificially high, the standard cost of goods sold also will be artificially high, and then the division’s net operating income will be depressed until the favorable variances are recognized. If Lansing saves the favorable variances, he can release just enough in the second and third quarters to show some improvement and then he can release all of the rest in the last quarter, by creating Is this essay helpful?
Join OPPapers to read more and access more than 650,000 just like it! get better grades the annual Christmas present. The problem is any inventory is to be overvalued because of wrong standards. Finished goods inventory is valued at the standard cost. If there is a lot of inventory at an inflated cost, then the cost of goods sold is being reduced on the income statement too much because of this. If the inventory were to be revalued at its correct standard cost, there would be a large expense to the income statement. It is better to build a inventory each quarter. ) Should Preston Lansing be permitted to continue his practice of managing reported earning? He should not permit to continue this practice, because it distorts the quarterly earnings for both the division and the company. The distortions of the division’s quarterly earnings are troubling because the manipulations may mask real signs of trouble and it may mislead external users of the financial statements. Lansing should not be rewarded for manipulating earnings because the permissive attitude of top… Posting 2 CASE 9–26 Ethics and the Manager [LO3]
Lance Prating is the controller of the Colorado Springs manufacturing facility of Prudhom Enterprises, Inc. The annual cost control report is one of the many reports that must be filed with corporate headquarters and is due at corporate headquarters shortly after the beginning of the New Year. Prating does not like putting work off to the last minute, so just before Christmas he prepared a preliminary draft of the cost control report. Some adjustments would later be required for transactions that occur between Christmas and New Year’s Day.
A copy of the preliminary draft report, which Prating completed on December 21, follows: Tab Kapp, the general manager at the Colorado Springs facility, asked to see a copy of the preliminary draft report. Prating carried a copy of the report to Kapp’s office where the following discussion took place: * Kapp: Wow! Almost all of the variances on the report are unfavorable. The only favorable variances are for supervisory salaries and industrial engineering. How did we have an unfavorable variance for depreciation? * Prating: Do you remember that milling machine that broke down because the wrong lubricant was used by the achine operator? * Kapp: Yes. Prating: We couldn’t fix it. We had to scrap the machine and buy a new one. Kapp: This report doesn’t look good. I was raked over the coals last year when we had just a few unfavorable variances. * Prating: I’m afraid the final report is going to look even worse * Kapp: Oh? Prating: The line item for industrial engineering on the report is for work we hired Sanchez Engineering to do for us. The original contract was for $160,000, but we asked them to do some additional work that was not in the contract. We have to reimburse Sanchez Engineering for the costs of that additional work.
The $154,000 in actual costs that appears on the preliminary draft report reflects only their billings up through December 21. The last bill they had sent us was on November 28, and they completed the project just last week. Yesterday I got a call from Mary Jurney over at Sanchez and she said they would be sending us a final bill for the project before the end of the year. The total bill, including the reimbursements for the additional work, is going to be…Kapp: I am not sure I want to hear this. * Prating: $176,000Kapp: Ouch! Prating: The additional work added $16,000 to the cost of the project.