Question

Sara Chapman knew the construction contractors in her area well. She was the HR manager at the power plant, a business that was the major employer in the region. Whenever a repair or maintenance job came up, Sara would hire her friends as independent contractors instead of collecting bids for the job or hiring an employee. Upon completion of the job, the independent contractors would inflate the invoice by 10% for “unanticipated additional costs” and would then kick back the extra 10% to Sara under the table. The invoice would pass through the accounts payable department, where the clerk was supposed to review and verify the charges before processing the payment. The accounts payable clerk, Valerie Judson, was happy to have a job and didn’t want anything to jeopardize it. She knew what was going on, but didn’t say anything. One day, Valerie had a heart attack and went into the hospital. The company hired a temporary accounts payable clerk, Spencer Finn, to fill in while Valerie recuperated. He had worked construction during his college days and suspected that something was fishy, but he didn’t know how to prove it.

1. What impact(s) will these actions have on the company’s financial statements? Be sure to discuss the balance sheet and the income statement separately, and be specific about the impacts on each statement (i.e. overstatement/understatement of account balances and net income).

2. Discuss the role that accounting should play (or should have played) in this situation. How can Spencer prove that “something fishy” is, in fact, going on?

3. Discuss the ethical issues in this case (be sure to identify each party involved and whether or not they are acting in an ethical manner).

4. Identify who could be harmed and how they could be harmed (be specific). Do not include Sara, Valerie, or Spencer.

5. As a personal friend, what advice would you give to Spencer?

Answer 1

1. Since the company is overstating expenses the income statement will show a lower income. Further, the accounts payable in the balance sheet shall be overstated to the extent they are unpaid.

2. Accounting should have segregated the addtional fictitious charges under a separate hand. A sustantial amount of expenses would have added up month on month in that account. These could be then questioned and the "Something fishy" part could be proved.

3. Sara Chapman is acting highly unethically as she is deriving personal benefit and is completely neglecting company's interests.

Valerie also acted unethically as she knew what was going on but did not bring to anyone's notice.

4. The stakeholders of the company ie.. the investors and creditors could be harmed by misleading financial statements and reduction in dividends due to lower profit.

5. As a personal friend, I would suggest Spencer to do a trend analysis of the increase in expenses in comparison to industry standards and ask him to bring to the notice of the management.