Case 2-7
Milton Manufacturing Company
Milton Manufacturing Company produces a variety of textiles for distribution to wholesale manufacturers
of clothing products. The company’s primary operations are located in Long Island City, New York, with
branch factories and warehouses in several surrounding cities. Milton Manufacturing is a closely held
company. Irv Milton is the president of the company. He started the business in 2002 and it grew in revenue
from $500,000 to $5.0 million in 10 years. However, the revenues declined to $4.5 million in 2012. Net
cash flows from all activities also were declining. The company was concerned because it planned to
borrow $20 million from the credit markets in the fourth quarter of 2013.
Irv Milton met with Ann Plotkin, the chief accounting officer (CAO), on January 15, 2013, to discuss a
proposal by Plotkin to control cash outflows. She was not overly concerned about the recent decline in net
cash flows from operating activities because these amounts were expected to increase in 2013, as a result of
projected higher levels of revenue and cash collections.
Plotkin knew that if overall capital expenditures continued to increase at the rate of 26 percent per year,
Milton Manufacturing probably would not be able to borrow the $20 million. Therefore, she suggested
establishing a new policy to be instituted on a temporary basis. Each plant’s capital expenditures for 2013
would be limited to the level of capital expenditures in 2011. Irv Milton pointedly asked Plotkin about the
possible negative effects of such a policy, but in the end Milton was convinced it was necessary to initiate
the policy immediately to stem the tide of increases in capital expenditures. A summary of cash flows
appears in Exhibit 1.
Sammie Markowicz is the plant manager at the headquarters location in Long Island City. He was
informed of the new capital expenditure policy by Ira Sugofsky, the vice president for operations.
Markowicz told Sugofsky that the new policy could negatively affect plant operations because certain
machinery and equipment, essential to the production process, had been breaking down more frequently
during the past two years. The problem was primarily with the motors. New and better models with more
efficient motors had been developed by an overseas supplier. These were expected to be available by April
2013. Markowicz planned to order 1,000 of these new motors for the Long Island City operation, and he
expected that other plant managers would do the same. Sugofsky told Markowicz to delay the acquisition
of new motors for one year after which time the restrictive capital expenditure policy would be lifted.
Markowicz reluctantly agreed.
Milton Manufacturing operated profitably during the first six months of 2013. Net cash inflows from
investing activities exceeded outflows by $250,000 during this time period. It was the first time in three
years there was a positive cash flow from investing activities. Production operations accelerated during the
third quarter as a result of increased demand for Milton’s textiles. An aggressive advertising campaign
initiated in late 2012 seemed to bear fruit for the company. Unfortunately, the increased level of production
put pressure on the machines and the degree of breakdown was increasing. A big problem was that the
motors wore out prematurely.
EXHIBIT 1
MILTON MANUFACTURING COMPANY
Summary of Cash Flows
For the Years Ended December 31, 2012 and 20011 (000 omitted)
December 31, 2012 December 31, 2011
Cash Flows from Operating Activities
Net income $ 372 $ 542
Adjustments to reconcile net income to net cash provided by
operating activities 1,350 1,383
Net cash provided by operating activities $ 1,722 $
1,925
Cash Flows from Investing Activities
Capital expenditures $ (2,420) $ (1,918)
Other investing inflows (outflows) 176 84
Net cash used in investing activities $ (2,244) $
(1,834)
Cash Flows from Financing Activities
Net cash provided (used in) financing activities $ 168 $
(376)
Increase (decrease) in cash and cash equivalents $ (354) $ (285)
Cash and cash equivalents—beginning of the year $ 506 $
791
Cash and cash equivalents—end of the year $ 152 $ 506
Markowicz was concerned about the machine breakdown and increasing delays in meeting customer
demands for the shipment of the textile products. He met with the other branch plant managers who
complained bitterly to him about not being able to spend the money to acquire new motors. Markowicz was
very sensitive to their needs. He informed them that the company’s regular supplier had recently announced
a 25 percent price increase for the motors. Other suppliers followed suit and Markowicz saw no choice but
to buy the motors from the overseas supplier. That supplier’s price was lower, and the quality of the motors
would significantly enhance the machines’ operating efficiency. However, the company’s restrictions on
capital expenditures stood in the way of making the purchase.
Markowicz approached Sugofsky and told him about the machine breakdowns and concerns of other
plant managers. Sugofsky seemed indifferent. He reminded Markowicz of the capital expenditure
restrictions in place and that the Long Island City plant was committed to make expenditures at the same
level as it had in 2011. Markowicz argued that he was faced with an unusual situation and he had to act
now. Sugofsky hurriedly left but not before he said to Markowicz: “A policy is a policy.”
Markowicz reflected on the comment and his obligations to Milton Manufacturing. He was conflicted
because he viewed his primary responsibility and that of the other plant managers to ensure that the
production process operated smoothly. The last thing the workers needed right now was a stoppage of
production because of machine failure.
At this time, Markowicz learned of a 30-day promotional price offered by the overseas supplier to gain
new customers by lowering the price for all motors by 25 percent. Coupled with the 25 percent increase in
price by the company’s supplier, Markowicz knew he could save the company $1,500, or 50 percent of
cost, on each motor purchased from the overseas supplier.
After carefully considering the implications of his intended action, Markowicz contacted the other plant
managers and informed them that while they were not obligated to follow his lead because of the capital
expenditure policy, he planned to purchase 1,000 motors from the overseas supplier for the headquarters
plant in Long Island City.
Markowicz made the purchase in the fourth quarter of 2013 without informing Sugofsky. He convinced
the plant accountant to record the $1.5 million expenditure as an operating (not capital) expenditure
because he knew the higher level of operating cash inflows would mask the effect of his expenditure. In
fact, Markowicz was proud that he had “saved” the company $1.5 million and he did what was necessary to
ensure that the Long Island City plant continued to operate.
The acquisitions by Markowicz and the other plant managers enabled the company to keep up with the
growing demand for textiles and the company finished the year with record high levels of net cash inflows
from all activities. Markowicz was lauded by his team for his leadership. The company successfully
executed a loan agreement with Second Bankers Hours & Trust Co. The $20 million borrowed was
received on January 3, 2014.
During the course of an internal audit on January 21, 2014, Beverly Wald, the chief internal auditor who
is a CPA, discovered that there was an unusually high level of motors in the inventory. A complete check of
inventory determined that $1.0 million of motors remained on hand.
Wald reported her findings to Ann Plotkin and together they went to see Irv Milton. After being
informed of the situation, Milton called in Ira Sugofsky. When Wald told him about her findings,
Sugofsky’s face turned beet red. He paced the floor, poured a glass of water, drank it quickly, and then
began his explanation. Sugofsky told them about his encounter with Sammie Markowicz. Sugofsky stated
in no uncertain terms that he had told Markowicz not to increase plant expenditures beyond the 2011 level.
“I left the meeting believing that he understood the company’s policy. I knew nothing about the purchase,”
he stated.
At this point Wald joined in and explained to Sugofsky that the $1 million is accounted for as inventory
and not an operating cash outflow: “What we do in this case is transfer the motors out of inventory and into
the machinery account once they are placed into operation because, according to the documentation, the
motors added significant value to the asset.” Sugofsky had a perplexed look on his face. Finally, Irv Milton
took control of the accounting lesson by asking: “What’s the difference? Isn’t the main issue that
Markowicz did not follow company policy?” The three officers in the room shook their head
simultaneously, perhaps in gratitude for being saved the additional lecturing. Milton then said he wanted
the three of them to brainstorm some alternatives on how best to deal with the Sammie Markowicz situation
and present the alternatives to him in one week.
NOTES
This case deals with a company’s efforts to manage its short-term earnings and cash outflows by restricting
capital expenditures.
Ethical Issues
Top management ‘s decision to restrict capital expenditures created a conflict for Sammie Markowicz, the
plant manager at the headquarters location in Long Island City. On the one hand, Markowicz knows that the
company expects him to follow company policy. On the other hand, he is very conscious of his primary
responsibility to keep the production process operating as efficiently as possible. Markowicz was placed in
a difficult position because of the capital expenditure restrictions, especially in light of the previously
experienced machine breakdowns. The conflict comes to a head for Markowicz when he learns about the
25% price increase that is announced by the plant’s primary supplier for motors used in the production
process.
Markowicz’ decision to order $150,000 of the motors for the Long Island City plant influences other plant
managers to take similar actions. He acted in a way that he thought would be in the best interest of the
company even though it violated company policy. He failed to consider the consequences of his action on
the stakeholders. At a minimum, Markowicz could have contacted top management with his dilemma and
sought a reversal of the policy by emphasizing the more frequent machine break downs and pending price
increase. Markowicz was wrong to hide the acquisition of an asset by charging it to expense. This action
violates the rights of the stockholders who rely on accurate financial information. Markowicz’s action were
primarily motivated by self-interest (reasoning at stage 2) and not out of concern for the interests of the
stakeholders. An issue that should be dealt with by the company is how and why Markowicz was able to
circumvent the interest controls and override the policy.
Questions
Use the Integrated Ethical Decision-Making Process explained in this chapter to help you assess the
following:
1. Identify the ethical and professional issues of concern to Beverly Wald in this case.
The ethical issues for Beverly Wald are the recording, transparency and disclosure of
accounting transactions and the resulting financial statements. There could be question of
whether the bank would have made the loan if the proper accounting treatment had been
reflected in the financial statements. Fraud appears to be involved in the situation because
2. Identify and evaluate the alternative courses of action for Wald, Ann Plotkin, and Ira
Sugofsky to present in their meeting with Milton.
Wald, Plotkin, and Sugofsky may consider the following alternatives. (1) The company
can pretend that management did not know or notice the violation of the policy. This
alternative may be a rationalization of act-utilitarianism. The company used the
accounting to secure new funding. Since everything seems to have worked for the best,
although not through ethical means, there may be no need to take any further action. The
company could counsel Markowicz to not do it again. Thus, this approach may be labeled
3. How do virtue considerations influence the alternatives presented?
The virtues to set an ethical tone in a company include trustworthiness, honesty, integrity,
4. If you were in Milton’s place, which of the alternatives would you choose and why?
Being in Milton’s place, alternative (2) of restating the financial statements and letting the
lender know should be chosen. Further the punishment of Markowicz should be
considered to set an ethical tone in the firm. The company should work on better internal
communication. Employees should feel comfortable to bring matters to their superiors