Henry Maddox was recently promoted to Controller of Research and Development for Pharmex, a Fortune 500 pharmaceutical company that manufactures prescription drugs and nutritional supplements. The company’s total R&D cost for 2020 was expected (budgeted) to be $5 billion. During the company’s midyear budget review, Maddox realized that current R&D expenditures were already at $3.5 billion, nearly 40% above the midyear target. At this current rate of expenditure, the R&D division was on track to exceed its total year-end budget by $2 billion! 

In a meeting with CFO Emily Alford later that day, Maddox delivered the bad news. Alford was both shocked and outraged that the R&D spending had gotten out of control. Alford wasn’t any more understanding when Maddox revealed that the excess cost was entirely related to research and development of a new drug, Amiven, which was expected to go to market next year. The new drug would result in large profits for Pharmex, if the product could be approved by year-end.
Alford had already announced her expectations of third-quarter earnings to Wall Street analysts. If the R&D expenditures weren’t reduced by the end of the third quarter, Alford was certain that the targets she had announced publicly would be missed and the company’s stock price would tumble. Alford instructed Maddox to make up the budget shortfall by the end of the third quarter using “whatever means necessary.” Maddox was new to the controller’s position and wanted to make sure that Alford’s orders were followed.
Maddox came up with the following ideas for making the third-quarter budgeted targets:
a. Cut planned bonuses to the Amiven R&D team that would be paid in the third quarter, knowing that doing so may result in lower productivity and increased turnover of highly skilled staff.
b. Sell off rights to the drug Centrix. The company had not planned on doing this because, under current market conditions, it would get less than fair value. It would, however, result in a one-time gain that could offset the budget shortfall. Of course, all future profits from Centrix would be lost.
c. Capitalize some of the company’s R&D expenditures, reducing R&D expense on the income statement. This transaction would not be in accordance with GAAP, but Maddox thought it was justifiable because the Amiven drug was going to market early next year. Maddox would argue that capitalizing R&D costs this year and expensing them next year would better match revenues and expenses.

Required

1. Referring to the “Standards of Ethical Behavior for Practitioners of Management Accounting and Financial Management,” Exhibit 1-7 (page 35), which of the preceding items (a–c) are acceptable to use? Which are unacceptable?

2. What would you recommend Maddox do?

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STATEMENT OF ETHICAL PROFESSIONAL PRACTICE Members of IMA shall behave ethically. A commitment to ethical professional practice includes overarching principles that express our values and standards that guide member conduct. PRINCIPLES IMA's overarching ethical principles include: Honesty, Fairness, Objectivity, and Responsibility. Members shall act in accordance with these principles and shall encourage others within their organizations to adhere to them. STANDARDS IMA members have a responsibility to comply with and uphold the standards of Competence, Confidentiality, Integrity, and Credibility. Failure to comply may result in disciplinary action. L. COMPETENCE 1. Maintain an appropriate level of professional leadership and expertise by enhancing knowledge and skills. 2. Perform professional duties in accordance with relevant laws, regulations, and technical standards. 3. Provide decision support information and recommendations that are accurate, clear, concise, and timely. Recognize and help manage risk. II. CONFIDENTIALITY 1. Keep information confidential except when disclosure is authorized or legally required. 2. Inform all relevant parties regarding appropriate use of confidential information. Monitor to ensure compliance. 3. Refrain from using confidential information for unethical or illegal advantage. III. INTEGRITY 1. Mitigate actual conflicts of interest. Regularly communicate with business associates to avoid apparent conflicts of interest. Advise all parties of any potential conflicts of interest. 2. Refrain from engaging in any conduct that would prejudice carrying out duties ethically. 3. Abstain from engaging in or supporting any activity that might discredit the profession. 4. Contribute to a positive ethical culture and place integrity of the profession above personal interests. IV. CREDIBILITY 1. Communicate information fairly and objectively. 2. Provide all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, analyses, or recommendations. 3. Report any delays or deficiencies in information, timeliness, processing, or internal controls in conformance with organization policy and/or applicable law. 4. Communicate professional limitations or other constraints that would preclude responsible judgment or successful performance of an activity. Source: IMA Statement of Ethical Professional Practice, 2017. Montvale, NJ: Institute of Management Accountants. Reprinted with permission from the Institute of Management Accountants, Montvale, NJ, www.imanet.org. EXHIBIT 1-7 Standards of Ethical Behavior for Practitioners of Management Accounting and Financial Management