ETM 7500 Module 1 Written Assignment: A Controller, a Covenant and a Warranty Reserve Example

Half a Point Above the Line: A Controller's Dilemma Over a Warranty Reserve

Student Name

Master of Business Administration, Thomas Edison State University

ETM-7500: Ethics for Managers

Mentor Name

Month Day, Year

Half a Point Above the Line: A Controller's Dilemma Over a Warranty Reserve

The Situation

Our company distributes furnaces, air conditioners and heat pumps to contractors across New Jersey and eastern Pennsylvania, with about $86 million in annual sales. The bank covenant caps our debt at three times EBITDA. At year end, preliminary figures put us at 3.06. The chief executive asked me to reduce our warranty reserve, the estimate of what we will spend honoring warranties on units already sold, from $1.12 million to $780,000, which would bring the ratio to 2.95. Jimenez and Pulos (2016) argue that a company's conduct is shaped by the pressures and incentives managers face, not only by individual character, which is why the covenant matters here.

The reserve is an estimate, and estimates involve judgment. But our claims data do not support the cut. A new heat pump line has a higher failure rate than our older products, and claims in the last two quarters ran 18 percent above the prior year. The lower figure would require assuming that trend reverses with no evidence that it will.

Where My Ethics Come From

I learned accounting from a professor who told our class that an accountant's signature is a promise to strangers. I have worked eleven years in finance, the last four as controller, and I hold one commitment above others: the numbers I sign should be my honest best estimate. Personal ethics, in Byars and Stanberry (2018), are what a manager carries into every business decision, and mine is simple in principle even when it is uncomfortable in practice.

Why Relativism Does Not Settle It

When I raised my concern, the chief executive said that every distributor sets reserves aggressively in a tight year and that the bank expects some management judgment. This is a relativist argument: the practice is acceptable because it is common. Even if it were common, which I doubt, frequency does not make a practice right. The question is whether the estimate is honest, not whether others shade theirs. Graham et al. (2005) found that most financial executives surveyed would sacrifice economic value to hit an earnings benchmark, which shows that the pressure is real and widespread, not that yielding to it is justified.

Evaluating the Request

Utilitarian reasoning. The cut would avoid a covenant breach, protecting the company from higher interest or a forced renegotiation, and perhaps protecting jobs. But it would mislead the bank about the company's risk, and the warranty costs would arrive anyway in the next year, worsening that year's results and the bank's trust when the truth emerged. If discovered, it could bring a default, legal liability and the loss of my professional license. The expected harms outweigh a one-year benefit.

Duty-based reasoning. Kant would ask whether every controller could follow the rule "move the reserve when a covenant is close." A rule that managers may understate liabilities whenever a covenant is at risk would make covenants meaningless, since lenders could never trust the figures that test them. The act also treats the bank as a means to the company's ends, deceiving it into extending credit on false terms.

Virtue reasoning. A controller of integrity reports honestly, especially when it is inconvenient, and has the courage to say so to a superior. Agreeing would make me the kind of accountant my professor warned against.

All three theories reach the same conclusion: the requested cut is wrong.

What I Will Do

Saying no is not enough; I owe the company a better path. I will record the reserve at $1.12 million and present the chief executive with three alternatives: contact the bank now, before the statements are issued, to request a one-time covenant waiver supported by the reasons for the warranty increase; propose a plan to recover the failure costs from the heat pump manufacturer, whose defect is driving the claims; and offer the bank a quarterly update on warranty experience. Banks generally prefer early, honest notice to a surprise. If the chief executive insists on the lower figure, I will take my concern to the audit committee.

Conclusion

The dilemma tested whether my commitment to honest estimates holds when it costs the company something. Ethical reasoning, unlike relativism, gives a clear answer, and it also points toward actions that protect the company better than the shortcut would.

References

Byars, S. M., & Stanberry, K. (2018). Business ethics. OpenStax.

Graham, J. R., Harvey, C. R., & Rajgopal, S. (2005). The economic implications of corporate financial reporting. Journal of Accounting and Economics, 40(1-3), 3-73. https://doi.org/10.1016/j.jacceco.2005.01.002

Jimenez, G. C., & Pulos, E. (2016). Good corporation, bad corporation: Corporate social responsibility in the global economy. Open SUNY Textbooks.