Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 23

CVP Analysis—Ethical Issues

Mark Ting desperately wants his proposed new product, DNA-diamond, to be accepted by top management. DNA-diamond is a piece of jewelry that contains the DNA of a boy or girl friend, spouse, or other loved one. Top management will not approve this product in view of its high break-even point.

Mark knows that if he can reduce the fixed costs in his proposal, then the break-even point will be reduced to a level that top management finds acceptable. Working with a friend in the company’s finance department, Mark finds ways to credibly misstate the estimated fixed costs of producing DNA-diamonds below those that any objective person would estimate.

Mark knows that if the product is successful (and he is certain that it will be), then top management will not find out about the understatement of fixed costs. Mark believes that this product, once it is successful, will benefit the shareholders and employees of the company.

Required

Are Mark’s actions ethical? Explain.

Step 1 of 4

Cost-volume-profit-analysis (CVP):

Cost-volume-profit-analysis is a financial modeling method that talks about break-even point basically. Thus in this modeling, we are more concerned with the zero profit-zero loss scenario where the profit equation is equated to zero.

In this context, the main focus is on achieving the break-even sales and the contribution margin. The sales volume, selling price and variable cost per unit are the main entities.

This gives rise to the contribution margin which offsets the fixed cost of the company. Here the actual sales volume, production capacity and the overheads leading to fixed cost are the key parameters of the model.