Question

The chief accountant of Gringotts Wizarding Bank believes that the bank’s allowance for doubtful debts should be 2% of Loans to Customers. The managing director of the bank is somewhat nervous that the shareholders might expect the bank to continue to achieve a 10% growth rate like it did last year. The managing director suggests that the chief accountant increase the allowance for doubtful debts to 5%. The managing director thinks that the lower profit, would reflect a lower growth rate, will be a more sustainable rate for the bank. Explain whether the managing director’s request poses an ethical dilemma for the chief accountant and why it may matter for interested parties?

Answer 1

The managing director’s request to increase the allowance for doubtful debts to 5% poses an ethical dilemma for the chief accountant. This is because here the managing director is asking the chief accountant to record the accounting transaction with regards to allowance for doubtful debts in an incorrect manner. The realistic allowance for doubtful debts should be 2% while the managing director wants to inflate it to 5%. Now a higher allowance for doubtful accounts will wrongly lower the profits of the company as a higher amount of initial charge will be recorded to bad debt expenses. Hence this is an ethical dilemma for the chief accountant.

It will matter for the interested parties as they will not get a correct picture with regards to the financial health of the company. There are several interested parties that rely on bank’s financial statements to make decisions. For instance investors and prospective shareholders will look at the bank’s financial numbers to determine the intrinsic value per share of the bank. By being shown an artificially deflated (or wrongly deflated) profit figures they will be led to incorrectly estimate the profit earning potential of the bank in future and hence will make the decision with regards to not investing or investing in the bank’s shares and this decision will be based on a wrong premise.