Question

Ozzie Foods Ltd produces several varieties of muesli and chocolate bars. An action has been brought against the company by a customer who broke a tooth while eating a muesli bar sold by Ozzie Foods Ltd. The chief accountant of Ozzie Foods Ltd, Col Gates, prepared a draft of the financial statements, including a note disclosure about the lawsuit. However, the chief executive officer, Wil MacLean, argued that the lawsuit should not be reported as a contingent liability because Ozzie Foods Ltd might win the case, and any mention of this incident in the financial statements might encourage more lawsuits and potentially increase the company’s liability.

Required

a)Define the ethical problem including identification of relevant stakeholders.

b)Ethical review–Identify two ethical principles that are relevant to the problem and explain why they are relevant.

c)Consider options: -Describetwo different courses of action, (i) and (ii), that Col Gates could take.

d)Investigate potential ethical outcomes for each course of action identified in part (c). You should consider multiple stakeholders in addressing this component and evaluate the outcome in terms of the principles identified in part (b).

e)Decideon action: Conclude by stating which course of action you think Col Gates should take and explain why, with reference to the principles stated in (b).

Answer 1

The given case is regarding recording or omitting of a contingent liability (a pending lawsuit) in the financial statements of the Company. The rules for recording of contingent liabilities are as follows:

1. Probable and amount can be estimated : If it is likely that the liability will arise (in this case, likelihood of losing the lawsuit) and amount of liability (damages to be paid under the lawsuit) can be fairly estimated, then such contingent liability must be recorded in the financial statements alongwith the estimated amount.

2. Possible : Contingent liabilities which are possible to arise but the amount cannot be estimated, must be recorded as footnotes to financial statements.

3. Remote: When the chances of contingent liability arising is remote, it can be ignored.

In the case, the CEO argues that the Company might win the case,i.e.,he is not highly confident that the Company will win the case thereby making the chances of losing lawsuit remote. So, the contingent liability comes under possible category, which is why the accountant included it as a note to financial statements.

Ans.A. The ethical problem faced by the accountant is hiding of material information or misreporting of facts. Further, it also amounts to conducting a breach of accounting principles. The various stakeholders affected in this are the external stakeholders who depend on the financial reports of Company for information required for their decision-making. These include the creditors of the Company, the shareholders, the suppliers,etc.

Ans.B. The ethical principles relevant here are :

1. Integrity & Objectivity : This principle requires truthful and fair reporting of data as it is and keeping the data free of any bias.

2. Professional behavior: This principle requires an accountant to be true to his profession in preparing financial statements applying all the accounting laws, principles and practices fairly and not misstating facts under the influence of anyone.

Ans.C. The choices available with the accountant, ColGates, are:

1. Comply with the CEO’s advice and remove the lawsuit (contingent liability) from the financial statements of the Company.

2. Deny the CEO’s request explaining him the accounting rules regarding categorizing of contingent liabilities and the reporting requirements in each case.

Ans.D. The potential outcomes in each of the choices described above are:

1. Comply with the CEO’s advice : This tantamounts to misreporting of financial information and is against the ethical principles of integrity, objectivity and professional behavior. This would affect the external stakeholders adversely who rely on financial statements for their decision-making (If the lawsuit damages arise in the future, it will badly impact the financials of the Company and thereby affect its stakeholders such as investors, creditors, suppliers). Also, when it arises, it might also put the accountant’s career at risk due to unprofessional behavior.

2. Deny the CEO’s advice: This way the accountant will uphold the ethical principles of accounting and be true to this profession. He will also be serving the stakeholders in their best interests’. The adverse outcome may be that the CEO may fire the accountant. However, he still can manage job in a new Company based on his integrity and professional behavior.

Ans.E. Based on above arguments, the accountant should deny the CEO’s advice and try to convince the CEO of the possible adverse outcomes of false reporting.