Question

Ethics and EPS – Change of Estimates

Acme Company has as a goal that its earnings per share should increase by at least 3% each year; this goal has been attained every year over the past decade. As a result, the market price per share of Acme's common stock also has increased each year. Last year (2019), Acme's earnings per share was $3. This year, however, is a different story. Because of decreasing sales, preliminary computations at the end of 2020 show that earnings per share will be only $2.99 per share.

You are the accountant for Acme. Acme's controller, Steve Bryan, has come to you with some suggestions. He says, “I've noticed that the decrease in revenues has been primarily related to credit sales. Since we have fewer credit sales, I believe we are justified in reducing our bad debts expense from 4% to 2% of net sales. I also think that because of the decreased sales, we won't use our factory equipment as much, so we can extend its estimated remaining life from 10 to 15 years for computing our straight-line depreciation expense. Based on my calculations, if we make these changes, Acme's 2030 earnings per share will be $3.06. This will sure make our shareholders happy, not to mention our CEO. You may even get a promotion. What do you think?”

Answer 1

In this question The company has target to increase its eps every year by 3%. The same had been achieved in the past. The same was reflected by its increasing share prices. But for the year 2013 on account of decreasing sales its estimated eps would be 2.99 per share. Jim one of the officers has come out with a plan to do some changes which will allow the eps to increase to 3.06 This is on account of few changes made by the officer in presenting some facts. The company had reduced the eps because of falling sales, Still it wants to report higher eps Ethically it is correct or not will depend on the facts on the basis of which it is reporting higher eps and the disclosure it makes in this regard

Here Jim wants to establish that on account of reduced credit sales which will in turn reduce the bad debts and since production is low then estimated life of machinery will go up and reduce the depreciation. It may true or may not be true since the management will have to establish that sales which reduced will also reduce the bad debts and the fall has not been due to poor quality of goods These are assumptions and on basis of this reporting a higher eps will not be a good policy,

Still if management wants to report higher eps on the face of the income statement then it should disclose all assumptions in the notes of accounts so that the users of financial statements can easily get the facts and make necessary enquiries to take informed decisions.