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Case 3-3
United Thermostatic Controls
United Thermostatic Controls is a publicly owned company that engages in the manufacturing and
marketing of residential and commercial thermostats. The thermostats are used to regulate temperature in
furnaces and refrigerators. United sells its product primarily to retailers in the domestic market, with the
company headquartered in San Jose, California. Its operations are decentralized according to geographic
region. As a publicly owned company, United’s common stock is listed and traded on the New York Stock
Exchange. The organization chart for United is presented in Figure 1 on page 156 of the chapter.
Frank Campbell is the director of the Southern sales division. Worsening regional economic conditions and
a reduced rate of demand for United’s products together have created pressures to nonetheless achieve sales
revenue targets set by United management. Also, significant pressures exist within the organization for
sales divisions to maximize their revenues and earnings for 2013 in anticipation of a public offering of
stock early in 2011 Budgeted and actual sales revenue amounts, by division, for the first three quarters in
2013 are presented in Exhibit 1.
Exhibit 1
United Thermostatic Controls
Budgeted and Actual Sales Revenue
First Three Quarters in 2013
U.S.A. Sales Division Western Sales Division
Quarter Ended Budget Actual % Var. Budget Actual % Var.
March 31 $ 632,000 $ 638,000 .009% $ 886,000 $ 898,000 .014%
June 30 640,000 642,000 .003 908,000 918,000 .011
September 30 648,000 656,000 .012 930,000 936,000 .006
Through Sept 30 $1,920,00 $1,936,000 .008% $2,724,00 $2,752,000 .010%
Eastern Sales Division Southern Sales Division
Quarter Ended Budget Actual % Var. Budget Actual % Var.
March 31 $ 743,000 $ 750,000 .009% $ 688,000 $ 680,000 (.012)%
June 30 752,000 760,000 .011 696,000 674,000 (.032)
September 30 761,000 769,000 .011 704,000 668,000 (.051)
Through Sept 30 $2,256,00 $2,279,000 .010% $2,088,00 $2,022,000 (.032)%
Campbell knows that actual sales lagged even further behind budgeted sales during the first two months of
the fourth quarter. He also knows that each of the other three sales divisions exceeded their budgeted sales
amounts during the first three quarters in 2013. He is very concerned that the Southern division has been
unable to meet or exceed budgeted sales amounts. He is particularly worried about the effect this might
have on his and the division managers’ bonuses and share of corporate profits.
In an attempt to improve the sales revenue of the Southern division for the fourth quarter and for the year
ended December 31, 2013, Campbell reviewed purchase orders received during the latter half of November
and early December to determine whether shipments could be made to customers prior to December 31.
Campbell knows that sometimes orders that are received before year-end can be filled by December 31,
thereby enabling the division to record the sales revenue during the current fiscal year. It could simply be a
matter of accelerating production and shipping to increase sales revenue for the year.
Reported sales revenue of the Southern division for the fourth quarter of 2013 was $792,000. This
represented an 18.6 percent increase over the actual sales revenue for the third quarter of the year. As a
result of this increase, reported sales revenue for the fourth quarter exceeded the budgeted amount by
$80,000, or 11.2 percent. Actual sales revenue for the year exceeded the budgeted amount for the Southern
division by $14,000, or .5 percent. Budgeted and actual sales revenue amounts, by division, for the year
ended December 31, 2013, are presented in Exhibit 2.
During the course of their test of controls, the internal audit staff questioned the appropriateness of
recording revenue of $150,000 on two shipments made by the Southern division in the fourth quarter of the
year. These shipments are described as follows:
1. United shipped thermostats to Allen Corporation on December 31, 2013, and billed Allen $85,000,
even though Allen had specified an earliest delivery date of February 1, 2014, to take control of the
product. Allen intended to use the thermostats in the heating system of a new building that would not be
ready for occupancy until March 1, 2014.
2. United shipped thermostats to Bilco Corporation on December 30, 2013, in partial (one-half)
fulfillment of an order. United recorded $65,000 revenue on that date. Bilco had previously specified that
partial shipments would not be accepted. Delivery of the full shipment had been scheduled for February 1,
2014.
EXHIBIT 2
United Thermostatic Controls
Budgeted and Actual Sales Revenue for the Year Ended December 31, 2013
U.S.A. Sales Division Western Sales Division
Quarter Ended Budget Actual % Var. Budget Actual % Var.
March 31 $ 632,000 $ 638,000 .009% $ 886,000 $ 898,000 .014%
June 30 640,000 642,000 .003 908,000 918,000 .011
September 30 648,000 656,000 .012 930,000 936,000 .006
December 31 656,000 662,000 .009 952,000 958,000 .006
2013 Totals $2,576,00 $2,598,000 .009% $3,676,00 $3,710,000 .009 %
Eastern Sales Division Southern Sales Division
Quarter Ended Budget Actual % Var. Budget Actual % Var.
March 31 $ 743,000 $ 750,000 .009% $ 688,000 $ 680,000 (.012)%
June 30 752,000 760,000 .011 696,000 674,000 (.032)
September 30 761,000 769,000 .011 704,000 668,000 (.051)
December 31 770,000 778,000 .010 712,000 792,000 .112
2013 Totals $3,026,00 $3,057,000 .010% $2,800,00 $2,814,000 .005%
During their investigation, the internal auditors learned that Campbell had placed pressure on United’s
accounting department to record these two shipments early to enable the Southern division to achieve its
goals with respect to the company’s revenue targets. The auditors were concerned about the appropriateness
of recording the $150,000 revenue in 2013 in the absence of an expressed or implied agreement with the
customers to accept and pay for the prematurely shipped merchandise. The auditors noted that, had the
revenue from these two shipments not been recorded, the Southern division’s actual sales for the fourth
quarter would have been below the budgeted amount by $70,000, or 9.8 percent. Actual sales revenue for
the year ended December 31, 2013, would have been below the budgeted amount by $136,000, or 4.9
percent. The revenue effect of the two shipments in question created a 5.4 percent shift in the variance
between actual and budgeted sales for the year. The auditors felt that this effect was significant with respect
to the division’s revenue and earnings for the fourth quarter and for the year ended December 31, 2013. The
auditors decided to take their concerns to Tony Cupertino, director of the internal auditing department.
Cupertino is a licensed CPA and holds the certified internal auditor (CIA) designation.
Cupertino discussed the situation with Campbell. Campbell informed Cupertino that he had received
assurances from Sam Lorenzo, executive vice president of sales and marketing, that top management would
support the recording of the $150,000 revenue because of its strong desire to meet or exceed budgeted
revenue and earnings amounts. Moreover, top management is very sensitive to the need to meet financial
analysts’ consensus earnings estimates. The company, according to Campbell, is concerned that earnings
must be high enough to meet analysts’ expectations because any other effect might cause the stock price to
go down. In fact, Lorenzo has already told Campbell that he did not see anything wrong with recording the
revenue in 2013, since the merchandise had been shipped to the customers before year-end and the terms of
shipment were FOB shipping point.
At this point, Cupertino is uncertain whether he should take his concerns to Walter Hayward, the chief
financial officer, who is also a member of the board of directors, or take them directly to the audit
committee. Cupertino knows that the majority of the members of the board, including those on the audit
committee, have ties to the company and members of top management. Cupertino is not even certain that
he should pursue the matter any further because of the financial performance pressures that exist within the
organization. However, he is very concerned about his responsibilities and obligations to coordinate the
work of the internal auditing department with that of the external auditors.
NOTES
This case focuses on the pressures that sometimes exist within an organization to manage short-term
earnings in order to meet or exceed budgeted levels or to improve the results of operations, cash flows, and
the financial position prior to a stock sale. Such actions can be unproductive and they contribute to a
questionable ethical culture.
Ethical Issues
It appears that Frank Campbell is attempting to manage the short-term earnings of the Southern sales
division to maximize the bonus payments to division managers. Investors rely on the accuracy of the
financial statement information. If revenue is deliberately overstated, then these users will be making
investment decisions based on incorrect information. The SEC expects a public company to report truthful
information in all of its filings with the Commission. The accounting profession (FASB, AICPA, IMA)
expects that its technical and ethical rules will be followed by all accountants – i.e., CPAs, and CMAs. The
accounting profession is harmed when an accountant compromises integrity by going along with a position
that is not justified under the rules. Under the AICPA Code, CPAs have an obligation to maintain integrity,
objectivity, and to follow GAAP. Under the IMA Code, CMAs have an obligation to the general public, the
members of their profession, the organization they serve, and themselves, to have integrity, objectivity, and
communicate information fairly and objectively.
From a rights perspective, it is not right to mislead the investors by making it look as though the company
is doing better than it really is. Any attempt to intentionally misstate the financial statements violates the
categorical imperative. Using a justice perspective, it is unfair to the other division managers whose
bonuses will be negatively affected by the improper recording of revenue and who have tried to do the right
thing. It is unfair to the external auditors who rely on the work of the internal auditors in determining the
extent of their audit procedures. It is unfair to the customer to ship merchandise prior to the agreement and
before they have any use for the thermostats. Act-utilitarianism requires that the act that creates the greatest
good for the greatest number of stakeholders should be selected. The only stakeholders to benefit from
recording the $150,000 revenue are Frank Campbell and other managers in the southern sales division. All
other stakeholders are harmed by this action, including the entity, because the SEC might impose sanctions
on the company if it does not adjust the revenue amount. Rule-utilitarianism requires that Cupertino should
pursue the matter further because of the violation of revenue recording rules. He fails to meet the
objectivity and integrity standards if he allows others to determine what is proper under GAAP. From a
virtue perspective, honesty requires that the statements should be truthful and recognize revenue using
generally accepted accounting principles. Objectivity requires that the company should approach its
decision about the proper revenue recognition procedure with fair-mindedness and without partially to one
set of stakeholders. Trustworthiness means that the accountants should not violate the investors’ faith that
the statements are accurate and reliable.
Questions
1. Identify the stakeholders in this case. Identify their interests and United’s obligations to satisfy
those interests from an ethical perspective.
The stakeholders and obligations to those stakeholders are as follows:
Top management of United and the company: United has a duty of trustworthiness, honesty,
Tony Cupertino: Cupertino is responsible for the integrity of the financial reporting process. One
factor in establishing the integrity of the reporting process is the strength of the internal controls.
Frank Campbell successfully circumvented the controls, apparently by pressuring the accountants
Frank Campbell and other division directors: The amount of revenue that is reported for the
Southern division for 2013 affects the bonus distribution to division managers. Cupertino has an
Current and potential investors: The investors rely on the financial information for their decision
The external auditors: The external auditors rely on the work of the internal accountants and
The regulators: The SEC and New York Stock Exchange expect a public company to report
The accounting profession: The accounting profession expects that its technical and ethical rules
2. Describe the ethical responsibilities of Tony Cupertino as a CPA and CIA. How do these
responsibilities effect whom Cupertino should approach in United based on the organization
chart?
Cupertino is responsible for the integrity of the financial reporting process. One factor in establishing the
integrity of the reporting process is the strength of the internal controls. Cupertino is not obligated to go
along with his superiors if he believes that revenue recognition is improper. As a CPA, Cupertino has
obligations under Rule 102 (Objectivity and Integrity) and 203 (GAAP conformity) of the AICPA Code to
pursue the matter further. He would subordinate his professional judgment if he allows others to determine
The reporting responsibilities in United present a barrier for Cupertino because he cannot go directly to the
3. Assume Tony Cupertino decides to delay contacting Walter Hayward and, instead,
Cupertino contacts the CFO of Bilco Corporation and offers a 20 percent discount on the total
$130,000 cost of merchandise if Bilco agrees to approve the partial shipment on December 30, 2013.
Cupertino adds that the $26,000 would be deducted from the remaining $65,000 to be shipped during
January 2014. Evaluate Cupertino’s actions with respect to the following:
a. Is the offer ethical or unethical? Why?
The offer is unethical as Cupertino has no authority to offer discounts or change sales agreements;
b. Has Cupertino violated any of his reporting responsibilities in directly contacting the CFO of
Bilco?
Cupertino has violated his reporting responsibilities in directly contacting the CFO of Bilco. He has
violated his integrity, objectivity, and competency. As an internal auditor, Cupertino is not supposed to be
