EXERCISE 3-17 (30 MINUTES)

5. One can argue that whether the “hat trick” is unethical depends on the

level of sophistication of the owners of the company and others who

read the financial statements. If they understand the effects of excess

production on net operating income and are not misled, it can be ar-

gued that the hat trick is ethical. However, if that were the case, there

does not seem to be any reason to use the hat trick. Why would the

owners want to tie up working capital in inventories just to artificially at-

tain a target net operating income for the period? And increasing the

rate of production toward the end of the year is likely to increase over-

head costs due to overtime and other costs. Building up inventories all

at once is very likely to be much more expensive than increasing the

rate of production uniformly throughout the year. In the case, we as-

Case 3-35 (45 minutes)