Question

Horizon Corporation manufactures personal computers. The company began operation in 2013 and reported profits for the years 2015 through 2018. Due primarily to increased competition and price slashing in the industry, 2019's income statement reported a loss of $20 million. Just before the end of the 2020 fiscal year, a memo from the company's chief financial officer to Jim Fielding, the company controller, included the following comments:

"If we don't do something about the large amount of unsold computers already manufactured, our auditors will require us to write them off. The resulting loss for 2020 will cause a violation of our debt covenants and force the company into bankruptcy. I suggest that you ship half of our inventory to J.B. Sales Inc., in Oklahoma City. I know the company's president and he will accept the merchandise and acknowledge the shipment as a purchase. We can record the sale in 2018 which will boost profits to an acceptable level. Then J.B. Sales will simply return the merchandise in 2019 after the financial statements have been issued.

Comment on the appropriateness of the suggestion made by the controller to fulfill financial reporting objectives, Consider relevant ethical issues in your response. A basic framework to address ethical decision-making is provided:

Ethics Discussion in Accounting:

There are many frameworks for the analysis of ethical dilemmas in Accounting. The basic steps include:

1. Identify the facts--who, what, where, when, and how.

2. Identify the ethical issue and the stakeholders such as shareholders, creditors, management, employees, potential investors, and the community.

3. Identify the values relevant to the situation such as confidentiality verses the right to know.

4. Specify the alternative courses of action.

5. Identify a course of action and the consequences of that action.¹

^{1. Adapted from Harold Q. Langenderfer and Joanne W. Rockness, "Integrating Ethics into the Accounting Curriculum:Issues, Problems, and Solutions," Issues in Accounting Education (Spring 1989)}

Answer 1

Question 1:

Discussion should include these elements.

Facts:

Horizon Corporation, a computer manufacturer, reported profits from 2015 through 2018, but reported a $20 million loss in 2019 due to increased competition. The chief financial officer (CFO) circulated a memo suggesting the shipment of computers to J.B. Sales, Inc., in 2020 with a subsequent return of the merchandise to Horizon in 2021. Horizon would record a sale for the computers in 2020 and avoid an inventory write-off that would place the company in a loss position for that year.

The CFO is clearly asking Jim Fielding to recognize revenue in 2020 which he knows will be reversed as a sales return in 2022.

Ethical Dilemma:

Is Jim's obligation to challenge the memo of the CFO and provide useful information to users of the financial statements greater than the obligation to prevent a company loss in 2020 that may lead to bankruptcy?

Affects

Jim Fielding

CFO and other managers

Other employees

Shareholders

Potential shareholders

Creditors

Auditors

What is the issue?

When the net realizable value of inventory falls below its cost, companies are required to write down inventory, resulting in a loss being reported in the income statement. The company’s assets (inventory) will also be reported for lower amounts, showing that the company’s resources have declined.

The financial effects of reporting this decline in inventory value will have severe consequences on the company’s ongoing operations. The company’s creditors will force the company into bankruptcy. By recording the fictitious sale, the company avoids having to record the inventory write down, and the company reports additional revenue from the sale.

Who are the parties involved?

Jim knows the importance to the company of reporting acceptable profits in 2018. If profits are too low, Jim will lose his job and so will all of his coworkers. However, reporting the sale would lead to misstated financial statements. Even if creditors are fooled for a short while, the company’s lack of profitability will eventually be discovered and likely lead to bankruptcy. The longer the company stays in business, the more money it could lose and the less creditors would be paid in bankruptcy proceedings. Therefore, not reporting accurately in 2018 could easily cause larger losses to creditors in the future. New investors could potentially suffer as well if their decision to invest in the business is based on financial reports prepared using misstated amounts.

What factors should Jim consider in making his decision?

Jim doesn’t want to be the one to blame for everyone losing their job. If he allows the “fake” sale to be reported, he and his coworkers will have time to start looking for other jobs. He will also please his boss, and if the company somehow is able to continue its existence, this could mean promotions and pay raises.

However, as the person responsible for preparing financial statements, Jim has an ethical responsibility to investors and creditors to accurately report the financial position of the company. Jim may face legal penalties for fraudulent reporting. In addition, by refusing to issue misleading financial statements, Jim sends a strong signal to upper management that he is someone who can be trusted. This could prove useful if the company maintains its business or in his career with another employer.