Question

Assume you are a newly hired accountant for a local manufacturing firm. You have enjoyed working for the company and are looking forward to your first experience participating in the preparation of the company’s financial statements for the year-ending December 31, the end of the company’s fiscal year.

As you are preparing your assigned journal entries, your supervisor approaches you and asks to speak with you. Your supervisor is concerned because, based on her preliminary estimates, the company will fall just shy of its financial targets for the year. If the estimates are true, this means that all 176 employees of the company will not receive year-end bonuses, which represent a significant portion of their pay.

One of the entries that you will prepare involves the upcoming bond interest payment that will be paid on January 15 of the next year. Your supervisor has calculated that, if the journal entry is dated on January 1 of the following year rather than on December 31 of the current year, the company will likely meet its financial goals thereby allowing all employees to receive year-end bonuses. Your supervisor asks you if you will consider dating the journal entry on January 1 instead of December 31 of the current year.

• Describe the implications to the various stakeholders
• What should your answer be? Explain.

Answer 1

Recording the entry for accrued interest payable on the bonds upto December 31st on January 1st of next year instead of December 31st of the current year will have implications for all stakeholders. This action would affect the interest of all stakeholders who rely upon the financial statements to get information about the state of affairs of the company. By not recording the entry for accrued interest, both the liabilities and interest expense will be understated. This means that on the one hand, the income of the firm will be overstated in the income statement, thus giving a rosy picture of the earnings, the understating of the liabilities in the statement of financial position will show a misleading picture of the true and actual obligations of the firm.

The implications of this action for various stakeholders will be as below:

Bondholders: Bondholders will be disturbed to know that the liability for the interest payable to them has not been provided for in the financial statements. This can shake their confidence in the safety of the bonds issued by the company and they may start selling the bonds in the market at a sharp discount. Some of bondholders may even file petitions in the court for bankruptcy of the company.

Stockholders: Stockholders would be misled about the financial health of the company. They may expect a dividend as the income would be overstated but will be disappointed when it does not materialize. Moreover, falsifying the financial statements generally becomes an issue of bad corporate governance which casts serious aspersions on the management. Should the fact of overstating the income or understating of the liabilities come to the knowledge of the stockholders, they may even sue the management of the company.

Investors: Investors too, would be misled by the rosy picture offered by the overstating of the earnings. If they invest in the company on the basis of the doctored financial statements, they might suffer losses later which will shake their confidence in the company. The share price of a company plummets steeply when the investors lose confidence in the company.

Lenders: Lenders too, could be misled by the doctored financial statements. Lenders lend primarily on the basis of the revenue generation ability of a company. The overstating of the earnings could lead them to feel smug and offer more loans. But if they come to know about the incorrectness of financial statements, their confidence in the company would be hit and they might stop further lendings.

Regulators and Govt. : Regulators and Govt. can take stringent action against the company such as fines, penalties, revocation of license, etc. for not preparing the financial statements as per Generally Accepted Accounting Principles (GAAP) and accounting conventions. Overstating the income would also penalize the company by way of payment of higher taxes than it would otherwise had been required to pay.

Needless to say that recording the entry for accrued interest payable on bonds on January 1st of next year instead of December 31st of the current year will have strong implications for all stakeholders concerned.

Hence, my answer to my supervisor will be to refuse to oblige him by doing what he asks me to do. I will straightaway refuse to date the journal entry on January 1 instead of December 31 of the current year. I would tell him that, as an accountant I am under a professional duty to prepare the books of accounts and the financial statements in accordance with the Generally Accepted Accounting Principles and accounting conventions. I would also tell him that trying to tinker with the accuracy and correctness of the accounts and financial statements for getting the year-end bonuses is downright unethical.

Hence, I would refuse to honour his instructions and should he persist, I will bring this to the knowledge of the senior management