Case 1-9
Cleveland Custom Cabinets
Note: A correction was made to the case in the text. The cost of direct materials used
should be $2,000,000. The cost of goods sold is both cost of goods manufactured and
sold.
Cleveland Custom Cabinets is a specialty cabinet manufacturer for high-end homes in the Cleveland
Heights and Shaker Heights areas. The company manufactures cabinets built to the specifications of
homeowners and employs 125 custom cabinet makers and installers. There are 30 administrative and sales
staff members working for the company.
James Leroy owns Cleveland Custom Cabinets. His accounting manager is Marcus Sims. Sims manages
15 accountants. The staff is responsible for keeping track of manufacturing costs by job and preparing
internal and external financial reports. The internal reports are used by management for decision making.
The external reports are used to support bank loan applications.
The company applies overhead to jobs based on direct labor hours. For 2014, it estimated total overhead
to be $9.6 million and 80,000 direct labor hours. The cost of direct materials used during the first quarter of
the year is $2,000,000 and direct labor cost is $400,000 (based on 20,000 hours worked). The company’s
accounting system is old and does not provide actual overhead information until about four weeks after the
close of a quarter. As a result, the applied overhead amount is used for quarterly reports.
On April 10, 2014, Leroy came into Sims’s office to pick up the quarterly report. He looked at it aghast.
Leroy had planned to take the statements to the bank the next day and meet with the vice president to
discuss a $1 million expansion loan. He knew the bank would be reluctant to grant the loan based on the
income numbers in Exhibit 1.
EXHIBIT 1
CLEVELAND CUSTOM CABINETS
Net Income for the Quarter Ended March 31, 2014
Sales $6,400,000
Cost of goods manufactured and sold 4,800,000
Gross margin $1,600,000
Selling and administrative expenses 1,510,000
Net income $ 90,000
Leroy asked Sims to explain how net income could have gone from 14.2 percent of sales for the year
ended December 31, 2013, to 1.4 percent for March 31, 2014. Sims pointed out that the estimated overhead
cost had doubled for 2014 when compared with the actual cost for 2013. He explained to Leroy that rent
had doubled and the cost of utilities skyrocketed. In addition, the custom-making machinery was wearing
out more rapidly so the company’s repair and maintenance costs also doubled from 2013.
Leroy understood but wouldn’t accept Sims’s explanation. Instead, he told Sims that as the sole owner of
the company, there was no reason not to “tweak” the numbers on a one-time basis. “I own the board of
directors so no worries there. Listen, this is a one-time deal. I won’t ask you to do it again,” Leroy stated.
Sims started to soften and asked Leroy just how he expected the tweaking to happen. Leroy flinched, held
up his hands, and said, “I’ll leave the creative accounting to you.”
NOTES
This case discusses subordination of judgment by an accountant, a cost accounting situation and the
difference between annual and quarterly reporting.
Ethical Issues
The stakeholders of the firm have a right to financial that follow GAAP and have adequate disclosures.
From a deontology perspective, Marcus Sims should follow the rules of the profession; i.e., GAAP and no
subordination of judgment. From a utilitarian perspective all the stakeholders should benefit, not just Leroy
the owner. In adjusting the numbers in order to obtain a bank loan, the bank could be greatly harmed in
order to benefit one stakeholder, Leroy. If Sims should give into Leroy, then it could be easier to
subordinate judgment in the future and may give Leroy the means to blackmail subordination easily.
Questions
1. Do you agree with Leroy’s statement that it doesn’t matter what the numbers look like since he is
the sole owner? Even if it is true that Sims “owns” the board of directors, what should be their
role in this matter?
No, Leroy is not the sole stakeholder to the firm. The firm has creditors (including the bank), customers,
employees, suppliers, and the government, who are all stakeholders. Leroy possibly has a spouse and
dependents who would share in gains and losses. From a rights perspective the stakeholders, other than
Leroy, have a right to truthful dealings (including financial statements) with the firm. From a deontology
2.a. Assume Sims is a CPA and holds the CMA. What are the ethical considerations for him in
deciding whether to tweak the numbers? What should Sims do and why?
Sims has an obligation to follow GAAP and not subordinate his judgment. Sims has to decide between
Sims would be dishonest to “tweak” the numbers. He might be able to get away with it one time, but would
Sims should not “tweak” the numbers. The chances are high that Leroy may fire him on the spot for not
b. Assume Sims did a utilitarian analysis to help decide what to do. Evaluate the harms and
benefits of alternative courses of action.
Using a utilitarian analysis, Sims may consider doing as requested by Leroy. This alternative may seems the
greatest good for all concerned as Cleveland Cabinets can continue in business; Leroy is happy that the
Sims may consider doing minor “tweaks” to the numbers, not as much as requested by Leroy. Sims may
hope that the minor “tweak” will be enough to satisfy the bank but be realistic to slow the amount of loans.
In this alternative, Cleveland Cabinets and Leroy might have to start tightening expenses and strategic plan
Sims could refuse to “tweak” the numbers. It is highly probably that Leroy will fire him on the spot. The
firm may have a rough time financially with reduced bank financing, possible bankruptcy, lay-offs, and
3. Assume Sims decided to reduce the estimated overhead for the year by 50 percent. How would
that change the net income for the quarter? What would it be as a percentage of sales? Do you
think Leroy would like the result? Do you think he will be content with the tweaking occurring
just this one time?
If the estimated overhead was reduced by 50 percent, the applied overhead rate would be $60 per hour,
Cleveland Custom Cabinets
Net Income for the Quarter Ended March 31, 2014
(Estimated Overhead Halved)
Sales $6,400,000
Cost of goods manufactured* 3,600,000
Gross margin $2,800,000
It would increase quarterly income by $1,200,000, about 20% of sales for the quarter. Leroy should like the
results of halving the estimated overhead.