Tom Brady is the relatively new controller of the Body and BathDivision of New Scotland Drugs (NSD). He completed his CPAdesignation three years earlier (at a major auditing firm inMoncton) and has worked at the Body and Bath Division for the pastsix months). The move to Halifax was a major decision for Tom, buthe is getting used to the climate and the new firm.

The Body and Bath Division (BPD) is located in Halifax, which isalso the headquarters of NSD. This location gives NSD excellentaccess to distribution networks across North America while enjoyingvery low operating costs. (Wages and occupancy costs in Halifax are40–60% lower than metropolitan centres like Vancouver orToronto.)

At the request of the division’s long-time president, BelindaBelichick, Brady developed a proposal for a new product to becalled Vital Hair. This product is a cream to be rubbed on thescalp to restore hair growth. The fixed costs associated with thedevelopment, production, and marketing of Vital Hair are$25,000,000. The majority of these costs are associated with thehuman trials needed to get federal health approval for this type ofproduct. Due to the nature of the product, it has to be monitoredby a doctor. Each customer will pay a doctor $98 per monthlytreatment, of which $68 is paid to NSD. Brady estimates NSD’svariable costs per treatment to be $28.50. Included in this is$9.25 for potential product litigation costs. Brady did someresearch on this type of product, and while most of the data camefrom the United States, he noticed that there is an increasingtrend in Canada for consumers to take companies to court for theslightest issue with a product.

Belinda Belichick and Brady are scheduled to make a presentationto the NSD executive committee on the expected profitability ofVital Hair. After reading Brady’s report, Belichick called him toher office. Belichick was livid at Brady for including the $9.25estimate. She argued that it is imperative to get the R&D fundsapproved (and quickly) and that any number that increases thebreakeven point reduces the likelihood of the Vital Hair projectbeing approved. She notes that NSD has had few successful lawsuitsagainst it, in contrast to some recent “horrendous” experiences ofcompetitors with breast implant products. Moreover, she was furiousthat Brady put the $9.25 amount in writing. “How do we know therewill be any litigation problem?” She suggested that Brady redo thereport excluding the $9.25 litigation risk cost estimate. “Put iton the whiteboard in the executive committee room, if you insist,but don’t put it in the report sent to the committee before themeeting. You can personally raise the issue at the executivecommittee meeting and have a full and frank discussion.”

Brady took Belichick’s “advice.” He changed the report’svariable cost to $19.25 per treatment. Although he felt uneasyabout the changes, he was comforted by the fact that he would flagthe $9.25 amount to the executive committee in his forthcoming oralpresentation.

One month later, Belichick walks into Brady’s office. She is ina buoyant mood and announces she has just come back from anexecutive committee meeting that approved the Vital Hair proposal.Brady asks why he was not invited to the meeting. Belichick saysthe meeting was held in Toronto, and she decided to save thedivision money by going alone. She then says to Brady, “It is nowtime to get behind the new venture and help make it the success thecommittee and the team members believe it will be.”

Required

1.            Whatis the breakeven point (in units of monthly treatments) when NSD’svariable costs (a) include the $9.25 estimate and (b) exclude the$9.25 estimate for potential product litigation costs?

2.            ShouldBrady have excluded the $9.25 estimate in his report to theexecutive committee of NSD? Explain your answer.

3.            Whatshould Brady do in response to Belichick’s decision to make thepresentation on her own? What options does he have? As a CPA whatare his responsibilities?