Question

Question 1 10 marks Charles, the CEO of JB Inc., and Frank, the accountant for JB Inc., were recently having a meeting to discuss the upcoming release of the company’s financial statements. Following is an excerpt of their conversation:

Charles: These financial statements do not show the hours of hard work that we have put in to restore this company to financial health. In fact, these results may actually prevent us from obtaining loans that are critical to our future.

Frank: Accounting does allow for judgment. Tell me your primary concerns, and let us see if we can work something out.

Charles: My first concern is that the company does not appear very liquid. As you can see, our current assets are only slightly more than current liabilities. The company has always paid its bills, even when cash was tight. It is not really fair that the financial statements don’t reflect this.

Frank: Well, we could reclassify some of the long-term investments as current assets instead of noncurrent assets. Our expectation is that we will hold these investments for several years, but we could sell them at any time; therefore, it is fair to count these as current assets. We could also reclassify some of the accounts payable as noncurrent. Even though we expect to pay them within the next year, no one will ever look close enough to see what we have done. Together these two changes should make us appear more liquid and properly reflect the hard work we have done.

Charles: I agree. However, if we make these changes, our long-term assets will be smaller and our long-term debt will be larger. Many analysts may view this as a sign of financial trouble. Is there not something we can do?

Frank: Our long-term assets are undervalued. Many were purchased years ago and recorded at historical cost. However, companies that bought similar assets are allowed to record them at an amount closer to their current market values. I have always thought this was misleading. If we increase the value of these long-term assets to their market value, this should provide the users of the financial statements with more relevant information and solve our problem, too.

Charles: Brilliant! Let us implement these actions quickly and get back to work.

Required: 1. Describe any ethical issues that might arise because of Charles and Frank’s conversation. (6)

2. Name at least 4 companies that misled its stakeholders by making use of Unethical accounting practices (4)

Answer 1

Required: 1. Describe any ethical issues that might arise because of Charles and Frank’s conversation. (6)

Ans

The ethical issues in accounting can be categorized as per following

• Fraudulent financial reporting – in this the accountants with the support and pressure from top management deliberately reports misstatement of financial statements to increase the topline and bottom line figures and favorable ratios to external stakeholders

The conversation between Charles and Frank’s points out the misstatement of current assets by increasing the value by re-classification of long term investments to short term investments. by reclassification of current liabilities to long term liabilities

• The revaluation of fixed assets at current market value is desirable if the prices or value will remain in current valuations or likely to increase in future.

Other categorization of ethical issues are

• Misappropriation of assets
• Disclosure violations

2. Name at least 4 companies that misled its stakeholders by making use of Unethical accounting practices (4)

Ans

The following companies misled stakeholders by making use of unethical accounting practices are

• Enron corporation they kept debts outside balance sheets
• Worldcom – they underreported line costs by capitalizing rather than expensing it off
• Tyco – they had shown inflated income of $500 million
• Lehman brothers – they had shown$50 billion as sales which actually were loans