Question

You have recently been hired as the assistant controller for Stub Industries, a large publicly held manufacturing company. Your immediate superior is the controller who, in turn, is responsible to the VP of Finance.

The controller has assigned you the task of preparing the year-end adjusting entries. In the receivable area, you have prepared an aging of accounts receivable and have applied historical percentages to the balances of each of the age categories. The analysis indicates that an appropriate balance for the allowance of uncollectible accounts s $180,000. The existing balance in the allowance account prior to any adjusting entry is $20,000 credit balance.

After showing your analysis to the controller, he tells you to change the aging category of a large account from over 120 days to current status and to prepare a new invoice to the customer with the revised date that agrees with the new aging category. This will change the required allowance for uncollectible accounts from $180,000 to $135,000. Tactfully, you ask the controller for an explanation for the change and he tells you “we need the extra income; the bottom line is too low.”

What is the effect of income before taxes of the change requested by the controller? Discuss the ethical dilemma you face. Discuss options? Discuss responsibilities and consequences of any actions you might take.

Answer 1

Bad debt expense on the income statement before the change = $ 180,000 - $ 20,000 = $ 160,000.

Bad debt expense on the income statement after the change = $ 135,000 - $ 20,000 = $ 115,000.

Effect of income before taxes of the change = $ 160,000 - $ 115,000 = $ 45,000 increase.

The financial statements are supposed to depict the true and fair view of the operating results of the business for the accounting period, and of the financial position as at the end of the accounting period. The change requested by the controller would result in overstatement of income by $ 45,000, with a corresponding overstatement of asset ( accounts receivable) by $ 45,000. Not only would there a violation of the conservatism principle of accounting, the users of the financial statements would also be misled into making incorrect economic decisions. As Stub Industries is a publicly held company, this change will increase the earnings per share of the company, and the market price of its stock.

Moreover, this earnings management is necessitated by the need of the controller to show a rosier picture than actual, either to retain his job or to earn an extra bonus. Hence there is a conflict of interest, where the controller lets his own interest come in the way of the interest of the company. This gives rise to the agency problem, which is the etical dilemma for you if you go along with the request of the controller.

You have the following options before you:

• Do as the controller says.
• Report the matter to the ethics committee of the company, if it has one.
• Write a mail to VP, Finance or to chairman of the board of directors.
• Report the matter to the SEC and become a whistle blower. Be prepared to be fired by the company.
• If nothing works, look for a job with another company with better work ethics, and put in your papers, but make sure that the hapless investors come to know about the lack of ethics in Stub Industries.