Question

Russell Company is a pesticide manufacturer. Its sales declined greatly this year due to the passage of legislation outlawing the sale of several of Russell’s chemical pesticides. In the coming year, Russell will have environmentally safe and competitive chemicals to replace these discontinued products. Sales in the next year are expected to greatly exceed any prior years. The decline in sales and profits appears to be a one-year aberration. Even so, the company president fears a large dip in the current year’s profits. He believes that such a dip could cause a significant drop in the market price of Russell’s stock and make the company a takeover target.

To avoid this possibility, the company president calls in Zoe Baas, controller, to discuss this period’s year-end adjusting entries. He urges her to accrue every possible revenue and to defer as many expenses as possible. He says to Zoe, “We need the revenues this year, and next year can easily absorb expenses deferred from this year. We can’t let our stock price be hammered down!” Zoe didn’t get around to recording the adjusting entries until January 17, but she dated the entries December 31 as if they were recorded then. Zoe also made every effort to comply with the president’s request.

1. Who are the stakeholders in this situation?
2. What are the ethical considerations of (a) the president’s request and (b) Zoe dating the adjusting entries December 31?
3. Can Zoe accrue revenues, defer expenses, and still be ethical?
4. Can Zoe’s accrued revenues and deferred expenses be illegal?
5. Who do you think can discover Zoe’s accrued revenues and deferred expenses?

Answer 1

(1): The stakeholders in this situation are the shareholders of the company and the management of the company. This is because in this case the decision to manipulate the profitability of the company will have a direct bearing on the stock prices and hence shareholders of the company will be affected. Management of the company are also a stakeholder in this case as they are involved in the decision making of the company and are taking accounting related decisions and making adjustments in books of accounts. The secondary or non-primary stakeholders will be employees, vendors and lenders who will also be impacted by the management’s decision to accrue every possible revenue and to defer as many expenses as possible.

(2): The president’s request is against the prudent accounting policies and will be construed as management’s attempt to window dress and manipulate accounting entries so as to post a better than actual profit numbers. This action is unethical. Zoe’s action of dating the adjusting entries December 31 instead of January 17 was done with a clear intention to manipulate the accounting figures and to inflate the company’s revenues by wrongly accruing some revenues and deflate expenses by wrongly deferring some expenses. This action is not only unethical but also illegal.

(3): Zoe can accrue revenues and defer expenses and still be ethical only if the accrual and deferment is done as per accounting provisions and the GAAP and IFRS framework. Otherwise it will not be ethical. For example when sales have occurred but have not been recorded through the normal invoicing paperwork then recording this as accrued sales is proper. But if customers have paid in advance and goods will be shipped next year then recording such transactions as accrued revenues will be unethical.

(4): Here again Zoe can accrue revenues and defer expenses and still be legal only if the accrual and deferment is done as per accounting provisions and the GAAP and IFRS framework and only when there is no violation of federal regulations and IRS regulations. But in case of those adjustments that will violate the accounting norms and federal regulations Zoe’s action of accruing revenues and deferring expenses will be illegal.

(5): The auditor of the company can easily discover Zoe’s accrued revenues and deferred expenses while examining the company’s books of accounts.