Question

Celia Lopez is a manager of a medium-size company. A few years ago, Lopez persuaded the owner to base a part of compensation on the net income the company earns each year. Each December, she estimates year-end financial figures in anticipation of the bonus she will receive. If the bonus is not as high as she would like, Lopez offers several recommendations to the accountant of the year-end adjustments. Once of her favorite recommendations is for the controller to reduce the estimate of doubtful accounts.

1. What effect does lowering of the estimate for doubtful accounts have on the income statement and balance sheet?
2. Do you believe Lopez' recommendation to adjust the allowance for doubtful accounts is within her rights as a manager, or do you believe the action is an ethics violation?  Justify your answer.
3. What type of internal control(s) might be useful for this company in overseeing the manager's recommendations for accounting changes?

Answer 1

1. By depressing the estimate for doubtful accounts on the income statement you would not have an precise financial depiction, the expenses would be understated and the net income would overstated.

2. Lopez ‘s reference to fine-tune the allowance for doubtful accounts is not within his privileges as a manager and is certainly an ethics defilement. It is clear that Lopez ‘s approval is self-serving and is made to profit only him. By lowering the estimate, the net income for the company would be overstated which would result in Lopez getting a higher bonus. This in no way is doing what is right for the company. An ethical manager would present an precise financial representation for the company even if it does not profit him but since that is what is best for the company. Many times important business decisions are made based on those financial statements and if they are not accurate it could be very detrimental to the company and the employees in the long run.

3. Internal controls are significant to make sure that entirety is being done correctly and that proper accounting principles are being followed. As someone whose bonus is affected directly by the company’s profit or loss, Lopez should not be able to make any decisions regarding changes in the accounting practices. These should be handled or at the very least reviewed by his superior, accounting department, or someone whose bonus doesn’t depend on the outcome. If Lopez is the only one available to make these decisions than the company better be auditing the books regularly or at the closing of each period.