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Case 7-6
Sweat Construction Company
During the past few years due to increasing competition, Sweat Construction Company has been more
aggressive in seeking out new business opportunities. One such opportunity is the Computer Assistance
Vocational Training School. It has contracted for a new 1-million-square-foot facility in San Marcos, Texas.
Computer Assistance trains computer programmers for jobs in business and government. It is the largest
computer training school in the southwestern United States.
Gabe Kohn is the passive owner of Sweat Construction. The company began operating in 2000, when
Kohn hired Michael Woody to be the president of the company. Sweat Construction is a family-owned
business that has been very successful as a mechanical contractor of heating, ventilation, and air-
conditioning systems. However, increased competition has put pressure on the company to diversify its
operations. Although it made a profit in 2011, the company’s net income for the year was 50 percent lower
than in previous years. As a result of these factors, the company decided to expand into plumbing and
electrical contract work.
In March 2012, Sweat Construction successfully bid for the Computer Assistance job. The company bid
low in order to secure the $3 million contract that is expected to be completed by June 30, 2013. Woody
knows that the company has little margin for error on the contract. The estimated gross margin of 11.5
percent is on the low side of historical margins, which have been between 10 to 15 percent on heating,
ventilation, and air-conditioning contracts. Because it is a fixed-price contract, the company will have to
absorb any cost overruns.
The Computer Assistance contract is an important one for Sweat Construction. It represents about 20
percent of the average annual revenues for the past five years. Moreover, First National Bank of Texas has
been pressuring the company to speed up its interest payments on a $2 million term loan payable to the
bank that is renewable on March 15, 2013. The company has been late in five of its last six monthly
payments. The main reason is that some of the company’s customers have been paying their bills later than
usual because of tight economic conditions. However, the company expects to get back on the right track
very soon after the Computer Assistance job begins.
Everything started out well on the contract. For the quarter ended June 30, 2012, Sweat Construction
had an estimated cumulative gross profit of $75,000 on the contract under the percentage-of-completion
method. This represents a 20 percent gross margin. Costs started to increase during the September quarter
and, even though cumulative gross margin decreased to 10 percent, it was still within projected amounts.
Unfortunately, the $54,000 estimated gross profit for the nine months ended December 31, 2012, represents
only a 3 percent gross margin for the first year of the contract. Exhibit 1 contains cost data, billings, and
collections for the year.
Exhibit 1
Sweat Hog Construction
Company Computer Assistance Contract
Year Ended December 31, 2012
Quarter Ending
June 30 September 30 December 31
Costs to date $ 300,000 $ 900,000 $1,740,000
Estimated costs to complete 2,100,000 1,800,000 1,170,000
Progress billings each quarter 250,000 600,000 950,000
Cash collections each quarter 150,000 350,000 400,000
Vinny Barbieri is a CPA and the controller of Sweat Construction. Barbieri knows that cash collections
on the Computer Assistance project have been slowing down—in part, because the company is behind
schedule—and tension has developed between the company and Computer Assistance. He decides to
contact Juan Santos, general manager for the project. Santos informs Barbieri that the tension between the
company and Computer Assistance escalated recently when Santos informed top management of Computer
Assistance that the electrical work may not be completed by the June 30, 2013, deadline. If the facility does
not open as scheduled for the summer months, Computer Assistance may be required to return deposits
from students. Consequently, it may lose out on the revenue that is projected for the July and August
summer term.
Woody calls for a meeting with Santos and Barbieri on February 6, 2014, to discuss the Computer
Assistance contract. Woody knows that Sweat Construction’s external auditors will begin their audit of the
December 31, 2013, year-end financial statements in two weeks. Woody wants to make sure the problems
with the contract have been corrected. He asks Barbieri to bring him up to date on the recent cost increases
on the contract.
Barbieri informs Woody that the internal job cost data indicate that $420,000 was incurred for the month
of January 2014. About 10 percent of the work was completed during that month. Barbieri emphasizes that
this is consistent with recent trend data that indicate the estimated costs to complete the contract have been
significantly understated. In fact, for the quarter ended December 31, 2013, the company lost
approximately $40,000 on the contract, although there is a cumulative gross margin of about $60,000 for
2013. However, this cumulative margin represents only 2 percent of revenue, and the gross margin
percentage is declining. Barbieri analyzed the cost data in preparation for the meeting. He estimates that
total costs on the contract may be as high as $4.2 million. He recommends that the $1.17 million estimate
to complete the contract at December 31, 2014, should be increased by at least $1 million.
Woody is stunned by this information. He cannot understand how the company got into this
predicament. The company has consistently made profits on its contracts, and there has never before been
any tension with clients. The timing is particularly troublesome, since First National Bank is expecting
audited financial statements by March 1, 2013. Woody asks Santos whether he agrees with Barbieri’s
assessment about the anticipated higher level of future costs. Santos hesitates, at first, but he eventually
admits to the likelihood of cost overruns. He points out that the workers are not as skilled with electrical
work as they are with heating, ventilation, and air-conditioning work. Consequently, some degree of
learning is taking place on the job.
Woody dismisses Santos at this point and asks Barbieri what would happen if the company reports the
estimated costs at December 31, 2012, without any adjustments. Woody emphasizes that the company
would make the necessary adjustments in the first quarter of 2013, and gross profit on the contract with
Computer Assistance ultimately will be correct. This approach would enable the company to renew its loan
and give it some time to rethink its business strategy.
Barbieri immediately tells Woody that he is not comfortable with this approach, since the profit on the
contract for the nine months ended December 31, 2012, would be significantly overstated. He points out
that the auditors are likely to question the low cost estimates. Woody becomes a bit irritated with Barbieri at
this point. He tells Barbieri that the bank is not likely to renew the company’s $2 million loan if the
statements reflect what Barbieri suggests. He concludes by stating: “The auditors have never been a
problem before. I do not expect any problems from them on this issue either, given that the firm has gone
along with whatever we’ve asked of them in the past.”
Question
Use the integrated ethical decision-making process described in Chapter 2 to evaluate the ethical and
professional issues in the case. What would you do if you were in Vinny Barbieri’s position?
The application of the integrated model in this case follows. Below is also the comprehensive decision
Integrated Ethical Decision Making Process
1. Ethical and Professional Issues
• Inadequacy of accounting estimates on the contract
• Using estimated costs than actual costs—integrity issues
• Ign oring ac tual cost s—due professional care issues
2. Evaluation of Alternatives
• Go along with Woody’s request to use estimated costs rather than actual costs: Violates laws
and regulations; violates accounting standards; inconsistent with professional obligations to
protect the public interest; violates fiduciary obligation to the public
3. Reflection
• Am I being true to myself and my personal and professional values if I take the intended action?
• Barbieri understood the importance of using actual costs and following GAAP
• Barbieri struggled with his conscience but this can be a sign of an ethical person being pressured;
4. Take Action
• What do I need to do to get my point across?
• Who should I approach?
Comprehensive Decision Making Model
Frame the ethical issue: The ethical issue is what cost estimates to use for the Computer Assistance
Gather all the facts: Sweat Hog Construction (traditionally a mechanical contractor of heating, ventilation,
and air-conditioning systems) expanded into plumbing and electrical contract work. The company low bid a
$3 million contract for the Computer Assistance job; it is a fixed-price contract to be completed mid-
2011.Sweat Hog has been late in payment on its bank loan due to the slow pay of customers in the tight
Identify the stakeholders and obligations: The stakeholders include: (1) Sweat Hog Construction, Gabe
Kohn, Michael Woody, Vinny Barbieri, Juan Santos, and the other employees of the company; (2) the
List the relevant core values involved in the situation: The core values and obligations of Barbieri are
Identify the operational issues: The company moved into an area of operations that they were not familiar
with because of the need to diversify during an economic downturn. Their inexperience in plumbing and
electrical contracting are partly to blame for the increased costs and slowdown in completing the project.
Identify the accounting issues: The percentage of completion method of accounting for construction
contracts is the preferred method for Sweat Hog’s accounting. In this case, the estimates of costs and
progress toward completion appear to be reliable. The problem is to get the company to act on the
List all the possible alternatives: Vinny Barbieri has two options – (1) to go along with Michael Woody’s
Make an ethical analysis of the alternatives: If Vinny should opt for alternative (1), he would likely retain
his job. He might be opting for a lot of heartburn as only egoism supports this alternative. If Vinny should
opt for alternative (2), the theories of utilitarianism, rights, justice, and virtue support this option. However,
Using the utilitarian perspective, Vinny should select the alternative required by the correct moral that
maximizes the net value to the stakeholders. The relevant information should be fully disclosed. The only
stakeholder that benefits from distorting the profit recognition on the contract is Michael Woody. If Vinny’s
recommendation is adopted, then the company will end up recording a loss in the last quarter and a
cumulative loss for the year. He believes that the ability of the company to successfully continue the First
National Bank financing is based on the continued profitability of the company. Some of the possible
implications of failing to accurately reflect profitability on the contract include: possible lawsuit by
The justice perspective requires fairness in reporting financial information. If Vinny decides to go along
with Michael, then the other stakeholders including the bank, the external auditors, and Gabe Kohn, would
Decide on a course of action: Having evaluated all the options, Vinny should go to Gabe Kohn and inform
him of the difference of opinion with Michael Woody. It is possible that Kohn will become more involved
in managing the business. This could be a positive step for the company because Michael is trying to
