Case study:

Ingrid is the CEO of Bathurst Bank, she is currently undergoing a dilemma on deciding a suitable replacement for an HR director position, as the current HR director Liz is going on a maternal leave. Ingrid has the options to either promote someone from Liz’s department to step in or find an external person to cover the maternal leave period on a shortterm contract. She has canvassed the team leaders of 4 sizeable teams that are under Liz’s management. The opinions and viewpoints expressed by the team leaders vary drastically.

Giovanni, the team leader of talent and development team, strongly recommends himself as the replacement person, while the other team leaders respond with anyone but Giovanni. According to Liz’s report on Giovanni’s last performance appraisal, Giovanni is an exceptional performer in the work he does and has a great ability to contribute to the organization. However, there are several complaints received regarding Giovanni’s poor conflict management skills and his ambiguous and competitive personality, both coming from his own team members and from other teams as well. Ingrid would like to keep Giovanni to stay with the company, without giving him this promotion, so she thinks of giving Giovanni a pay rise as a compensate.

In their meeting together, Giovanni is extremely shocked by Ingrid’s decision of asking an external person to be the replacement, as Giovanni has always thought he would be the best candidate for this promotion due to his outstanding performance. The meeting leaves Giovanni disappointed and Ingrid stressed. Later in the day, Giovanni sends a following up email to Ingrid, expressing that he is not particularly happy about Ingrid’s decision, he also expressed that if he doesn’t see a future here at Bathurst Bank, he will seek for alternative opportunities, and he really appreciates the pay rise but would rather see it as a token gesture rather than based on his actual performance at the organization. The email left Ingrid dreading about what to do with Giovanni.

Questions:

1. Should Ingrid have given Giovanni a Pay Raise? If so, discuss it in term of effectiveness and advantages.
2. Analysis for key reasons to Job Dissatisfaction

Daniel Sawyer, the CEO of the Sawyer Group, is initiating planning for the company's operations next year, and he wants you to forecast the firm's additional funds needed (AFN). The firm is operating at full capacity. Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year? Dollars are in millions.

Select the correct answer.

The Board of Directors of Northwind have appointed Doug Hanus at their new CEO and Jeff Hogan as their operational manager. They are planning to devote their first two weeks in office to gain a better understanding of Northwind’s supply chain and marketing processes. As senior database analyst for Northwind, it is your responsibility to code appropriately structured SQL statements for retrieving the following information requested by Doug and Jeff. They need it on or before 09/29/2019.

1. A listing of Northwind’s suppliers. [1 pt.]

2. A listing of Northwind’s suppliers based in Norway and Sweden. [2 pts]

3. A listing of Northwind’s product categories and the description of each product category. [2 pts]

4. A clearer picture of the geographical footprint of their customers and suppliers - they want separate listings of the countries in which their customers and suppliers are located. [2 pts]

5. The average, sum, maximum, and minimum per unit cost across all products in their product line. They would also like to know the names of Northwind’s products having per unit cost between 30 and 50 (both inclusive). [2 pts]

6. A count and a listing of the cities and corresponding countries in North America (USA, Canada, Mexico) where they have a customer base. [3 pts]

7. A listing of the product names and its corresponding category for products from suppliers based in Germany and France. [4 pts]

8. A list of countries outside of North America (i.e. USA, Canada, Mexico) where they have less than 3 suppliers. [4 pts]

9. For OrderIDs 10258, 10259, and 10260, a listing of the corresponding customer, employee who accepted the order, and the shipper. The listed must be sorted alphabetically by customer name. [5 pts]

10. A listing of the product names and supplier names for all products that make up OrderIDs 10254 and 10260. [5 pts]

The CEO of Garneau Cinemas is considering making a movie and must decide between a comedy and a thriller—it ​doesn't have the production space to make both. The comedy is expected to cost $25 million up front​ (at t​ = 0). After​ that, it is expected to make 16 million in the first year​ (at t​ = 1) and $44 million in each of the following two years​ (at t​ = 2 and t​ = 3). In the fourth year​ (at t​ = 5), it is expected that the movie can be sold into syndication for ​$22 million with no further cash flows back to Garneau Cinemas. The thriller is expected to cost ​$40 million up front​ (at t​ = 0). After​ that, it is expected to make $20 million in the first year​ (at t​ = 1) and $44 million in each of the following four years​ (at t​ = 2,​ 3, 4, and​ 5). In the sixth year​ (at t​ = 6), it is expected that the movie can be sold into syndication for $30 million with no further cash flows back to Garneau Cinemas. The cost of capital is 11​%,and Garneau usually requires projects to have a payback within four years. Determine each​ project's payback and​ NPV, and advise the CEO what she should do.

a) The payback for the comedy is _____ ​years, and the NPV of the comedy is $_____?

b) The payback for the thriller is _____ ​years, and the NPV of the thriller is $_____?

The CEO of Kingdom Ltd. is considering whether or not to convert the firm’s current all-equity capital structure to one that has 50% debt (by retiring equity and leaving its total value unchanged). Currently, the firm has 1,000 shares outstanding and its share price is $40. The firm’s business is quite mature and it expects to generate stable annual earnings before interest and tax (EBIT) at $2,000 forever. As the firm has no further growth opportunities, it practices a 100% dividend payout policy. The market interest rate on borrowing is 8%. Brian Ng, a major shareholder of the firm, owns 20% of the total shares. Assume there is no tax and all other assumptions in the M&M model are met, and that the share price does not change during the capital structure conversion. a.Compute the annual payout to Brian under BOTH the all-equity and the levered capital structure. Assume that he will keep all his 200 shares under the levered capital structure. b.If the firm decides to change to the new capital structure, show how Brian can use homemade leverage to resemble his payoff under the all-equity capital structure. Explain and comment on the implication of this.

Daniel Sawyer, the CEO of the Sawyer Group, is initiating planning for the company's operations next year, and he wants you to forecast the firm's additional funds needed (AFN). The firm is operating at full capacity. Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year? Dollars are in millions.

2. CEO committment is the highest weighted area of the four evaluated to select the DiversityInc top fifty companies for diversity. Leadership and governance is one of the four dimensions assessed in the Institute of Diversity in Health Management benchmarking survey. Using research findings, testimonies from experts, and logical argument, explain why leadership is key.

Comprehensive Accounting Cycle Review

15.ACR  Quigley Corporation's trial balance at December 31, 2020, is presented below. All 2020 transactions have been recorded except for the items described below.

Unrecorded transactions and adjustments:

• 1.On January 1, 2020, Quigley issued 1,000 shares of $20 par, 6% preferred stock for $22,000.
• 2.On January 1, 2020, Quigley also issued 1,000 shares of common stock for $23,000.
• 3.Quigley reacquired 300 shares of its common stock on July 1, 2020, for $49 per share.
• 4.On December 31, 2020, Quigley declared the annual cash dividend and a $1.50 per share dividend on the outstanding common stock, all payable on January 15, 2021.
• 5.Quigley estimates that uncollectible accounts receivable at year-end is $5,100.
• 6.The building is being depreciated using the straight-line method over 30 years. The salvage value is $5,000.
• 7.The equipment is being depreciated using the straight-line method over 10 years. The salvage value is $4,000.
• 8.The unearned rent was collected on October 1, 2020. It was the receipt of 4 months' rent in advance (October 1, 2020 through January 31, 2021).
• 9.The 10% bonds payable pay interest every January 1. The interest for the 12 months ended December 31, 2020, has not been paid or recorded.

Instructions

(Ignore income taxes.)

(d)  

Prepare a retained earnings statement for the year ending December 31, 2020.

(e)  

Prepare a classified balance sheet as of December 31, 2020.

Total assets $273,400

[The following information applies to the questions displayed below.]

Canada-based Nortel Networks was one of the largest telecommunications equipment companies in the world prior to its filing for bankruptcy protection on January 14, 2009, in the United States, Canada, and Europe. The company had been subjected to several financial reporting investigations by U.S. and Canadian securities agencies in 2004. The accounting irregularities centered on premature revenue recognition and hidden cash reserves used to manipulate financial statements. The goal was to present the company in a positive light so that investors would buy (hold) Nortel stock, thereby inflating the stock price. Although Nortel was an international company, the listing of its securities on U.S. stock exchanges subjected it to all SEC regulations, along with the requirement to register its financial statements with the SEC and prepare them in accordance with U.S. GAAP.

The company had gambled by investing heavily in Code Division Multiple Access (CDMA) wireless cellular technology during the 1990s in an attempt to gain access to the growing European and Asian markets. However, many wireless carriers in the aforementioned markets opted for rival Global System Mobile (GSM) wireless technology instead. Coupled with a worldwide economic slowdown in the technology sector, Nortel’s losses mounted to $27.3 billion by 2001, resulting in the termination of two-thirds of its workforce.

The Nortel fraud primarily involved four members of Nortel’s senior management as follows: CEO Frank Dunn, CFO Douglas Beatty, controller Michael Gollogly, and assistant controller Maryanne Pahapill. At the time of the audit, Dunn was a certified management accountant, while Beatty, Gollogly, and Pahapill were chartered accountants in Canada.

Accounting Irregularities

On March 12, 2007, the SEC alleged the following in a complaint against Nortel:1

In late 2000, Beatty and Pahapill implemented changes to Nortel’s revenue recognition policies that violated U.S. GAAP, specifically to pull forward revenue to meet publicly announced revenue targets. These actions improperly boosted Nortel’s fourth quarter and fiscal 2000 revenue by over $1 billion, while at the same time allowing the company to meet, but not exceed, market expectations. However, because their efforts pulled in more revenue than needed to meet those targets, Dunn, Beatty, and Pahapill selectively reversed certain revenue entries during the 2000 year-end closing process.

In November 2002, Dunn, Beatty, and Gollogly learned that Nortel was carrying over $300 million in excess reserves. The three did not release these excess reserves into income as required under U.S. GAAP. Instead, they concealed their existence and maintained them for later use. Further, Beatty, Dunn, and Gollogly directed the establishment of yet another $151 million in unnecessary reserves during the 2002 year-end closing process to avoid posting a profit and paying bonuses earlier than Dunn had predicted publicly. These reserve manipulations erased Nortel’s pro forma profit for the fourth quarter of 2002 and caused it to report a loss instead.2

In the first and second quarters of 2003, Dunn, Beatty, and Gollogly directed the release of at least $490 million of excess reserves specifically to boost earnings, fabricate profits, and pay bonuses. These efforts turned Nortel’s first-quarter 2003 loss into a reported profit under U.S. GAAP, which allowed Dunn to claim that he had brought Nortel to profitability a quarter ahead of schedule. In the second quarter of 2003, their efforts largely erased Nortel’s quarterly loss and generated a pro forma profit. In both quarters, Nortel posted sufficient earnings to pay tens of millions of dollars in so-called return to profitability bonuses, largely to a select group of senior managers.

During the second half of 2003, Dunn and Beatty repeatedly misled investors as to why Nortel was conducting a purportedly “comprehensive review” of its assets and liabilities, which resulted in Nortel’s restatement of approximately $948 million in liabilities in November 2003. Dunn and Beatty falsely represented to the public that the restatement was caused solely by internal control mistakes. In reality, Nortel’s first restatement was necessitated by the intentional improper handling of reserves, which occurred throughout Nortel for several years, and the first restatement effort was sharply limited to avoid uncovering Dunn, Beatty, and Gollogly’s earnings management activities.

The complaint charged Dunn, Beatty, Gollogly, and Pahapill with violating and/or aiding and abetting violations of the antifraud, reporting, and books and records requirements. In addition, they were charged with violating the Securities Exchange Act Section 13(b)(2)(B) that requires issuers to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that, among other things, transactions are recorded as necessary to permit the preparation of financial statements in conformity with U.S. GAAP and to maintain accountability for the issuer’s assets.

Dunn and Beatty were separately charged with violations of the officer certification provisions instituted by SOX under Section 302. The commission sought a permanent injunction, civil monetary penalties, officer and director bars, and disgorgement with prejudgment interest against all four defendants.

Specifics of Earnings Management Techniques

From the third quarter of 2000 through the first quarter of 2001, when Nortel reported its financial results for year-end 2000, Dunn, Beatty, and Pahapill altered Nortel’s revenue recognition policies to accelerate revenues as needed to meet Nortel’s quarterly and annual revenue guidance, and to hide the worsening condition of Nortel’s business. Techniques used to accomplish this goal include:

Reinstituting bill-and-hold transactions. The company tried to find a solution for the hundreds of millions of dollars in inventory that was sitting in Nortel’s warehouses and offsite storage locations. Revenues could not be recognized for this inventory because U.S. GAAP revenue recognition rules generally require goods to be delivered to the buyer before revenue can be recognized. This inventory grew, in part, because orders were slowing and, in June 2000, Nortel had banned bill-and-hold transactions from its sales and accounting practices. The company reinstituted bill-and-hold sales when it became clear that it fell short of earnings guidance. In all, Nortel accelerated into 2000 more than $1 billion in revenues through its improper use of bill-and-hold transactions.

Restructuring business-asset write-downs. Beginning in February 2001, Nortel suffered serious losses when it finally lowered its earnings guidance to account for the fact that its business was suffering from the same widespread economic downturn that affected the entire telecommunications industry. As Nortel’s business plummeted throughout the remainder of 2001, the company reacted by implementing a restructuring that, among other things, reduced its workforce by two-thirds and resulted in a significant write-down of assets.

Creating reserves. In relation to writing down the assets, Nortel established reserves that were used to manage earnings. Assisted by defendants Beatty and Gollogly, Dunn manipulated the company’s reserves to manage Nortel’s publicly reported earnings, create the false appearance that his leadership and business acumen was responsible for Nortel’s profitability, and pay bonuses to these three defendants and other Nortel executives.

Releasing reserves into income. From at least July 2002 through June 2003, Dunn, Beatty, and Gollogly released excess reserves to meet Dunn’s unrealistic and overly aggressive earnings targets. When Nortel internally (and unexpectedly) determined that it would return to profitability in the fourth quarter of 2002, the reserves were used to reduce earnings for the quarter, avoid reporting a profit earlier than Dunn had publicly predicted, and create a stockpile of reserves that could be (and were) released in the future as necessary to meet Dunn’s prediction of profitability by the second quarter of 2003. When 2003 turned out to be rockier than expected, Dunn, Beatty, and Gollogly orchestrated the release of excess reserves to cause Nortel to report a profit in the first quarter of 2003, a quarter earlier than the public expected, and to pay defendants and others substantial bonuses that were awarded for achieving profitability on a pro forma basis. Because their actions drew the attention of Nortel’s outside auditors, they made only a portion of the planned reserve releases. This allowed Nortel to report nearly break-even results (though not actual profit) and to show internally that the company had again reached profitability on a pro forma basis necessary to pay bonuses.

Siemens Reserve

During the fraud trial, former Nortel accountant Susan Shaw testified about one of the most controversial accounting provisions on the company’s books, relating to a 2001 lawsuit filed against Nortel by Siemens AG. It was long-standing practice across Nortel to establish reserves on a “worst case” basis, which meant at an amount equal to the maximum possible exposure.

Nortel had created an accounting reserve on its books at the time the Siemens lawsuit was filed to provide for a settlement in the case, but it was alleged that a portion of the provision was arbitrarily left on Nortel’s books long after the lawsuit was resolved in the fourth quarter of 2001. It became part of a group of extra head office, non-operating reserves that allegedly was reversed arbitrarily—and with no appropriate business trigger—to push the company into a profit in 2003 and earn “return to profitability” bonuses for executives.

The $4-million remaining Siemens provision was initially booked to be reversed into income in the first quarter of 2003, but then withdrawn, allegedly because it was not needed to push the company into a profitable position in the quarter. It was then booked to be used in the second quarter, and became the only head office non-operating reserve used in the quarter.

The contention was that the Siemens reserve was used in that quarter because Nortel needed almost exactly $4 million more income to reach the payout trigger for the company’s restricted share unit plan at that time. However, lawyer David Porter argued the Siemens amount was triggered in the second quarter because that is when the company believed it was no longer needed and should appropriately be reversed.

In cross-examination, Porter showed Shaw a working document recovered from the files of Nortel’s external auditors at Deloitte & Touche, showing the auditor reviewed Nortel’s justifications for keeping the Siemens reserve on the books until that time and for reversing it in the second quarter of 2003. Deloitte’s notes showed the auditor reviewed Nortel’s detailed rationale for the reserve and concluded its release in the second quarter was “reasonable.”3

The company said it was holding on to the reserve because the settlement with Siemens had been “rancorous” and Nortel wanted to be sure there would be no further claims made after the lawsuit was settled and $32 million was paid to Siemens in two installments in late 2001 and late 2002.

In its working notes, Deloitte recorded that Nortel felt it was “prudent” to keep the $4 million on the books until mid-2002. Shaw testified she felt the reserve was being reversed on schedule with the plan to keep it in place for the first two quarters of the year. Porter asked Shaw whether the auditors were satisfied at the time there was an appropriate triggering event to use the reserve in the second quarter of 2002, and she replied there was one.

However, the amount became part of a broad restatement of reserves announced at Nortel at the end of 2003. The company noted in the restatement that the Siemens reserve should have been reversed in the fourth quarter of 2001 when the lawsuit was settled.

Role of Auditors and Audit Committee

In late October 2000, as a first step toward reintroducing bill-and-hold transactions into Nortel’s sales and accounting practices, Nortel’s then controller and assistant controller asked Deloitte to explain, among other things, (1) “[u]nder what circumstances can revenue be recognized on product (merchandise) that has not been shipped to the end customer?” and (2) whether merchandise accounting can be used to recognized revenues “when installation is imminent” or “when installation is considered to be a minor portion of the contract”?4

On November 2, 2000, Deloitte presented Nortel with a set of charts that, among other things, explained the US GAAP criteria for revenues to be recognized prior to delivery (including additional factors to consider for a bill-and-hold transaction) and also provided an example of a customer request for a bill-and-hold sale “that would support the assertion that Nortel should recognize revenue” prior to delivery.

Nortel’s earnings management scheme began to unravel at the end of the second quarter of 2003. On the morning of July 24, 2003, the same day on which Nortel issued its second Quarter 2003 earnings release, Deloitte informed Nortel’s audit committee that it had found a “reportable condition” with respect to weaknesses in Nortel’s accounting for the establishment and disposition of reserves. Deloitte went on to explain that, in response to its concerns, Nortel’s management had undertaken a project to gather support and determine proper resolution of certain provision balances. Management, in fact, had undertaken this project because the auditor required adequate audit evidence for the upcoming year-end 2003 audit. Nortel concealed its auditor’s concerns from the public, instead disclosing the comprehensive review.

Shortly after Nortel’s announced restatement, the audit committee commenced an independent investigation and hired outside counsel to help it “gain a full understanding of the events that caused significant excess liabilities to be maintained on the balance sheet that needed to be restated,” as well as to recommend any necessary remedial measures. The investigation uncovered evidence that Dunn, Beatty, and Gollogly and certain other financial managers were responsible for Nortel’s improper use of reserves in the second half of 2002 and first half of 2003.

In March 2004, Nortel suspended Beatty and Gollogly and announced that it would “likely” need to revise and restate previously filed financial results further. Dunn, Beatty, and Gollogly were terminated for cause in April 2004.

On January 11, 2005, Nortel issued a second restatement that restated approximately $3.4 billion in misstated revenues and at least another $746 million in liabilities. All of the financial statement effects of the defendants’ two accounting fraud schemes were corrected as of this date, but there remained lingering effects from the defendants’ internal control and other nonfraud violations.

Nortel also disclosed the findings to date of the audit committee’s independent review, which concluded, among other things, that Dunn, Beatty, and Gollogly were responsible for Nortel’s improper use of reserves in the second half of 2002 and first half of 2003. The second restatement, however, did not reveal that Nortel’s top executives had also engaged in revenue recognition fraud in 2000.

In May 2006, in its Form 10-K for the period ending December 31, 2005, Nortel admitted for the first time that its restated revenues in part had resulted from management fraud, stating that “in an effort to meet internal and external targets, the senior corporate finance management team . . . changed the accounting policies of the company several times during 2000,” and that those changes were “driven by the need to close revenue and earnings gaps.”

Throughout their scheme, the defendants lied to Nortel’s independent auditor by making materially false and misleading statements and omissions in connection with the quarterly reviews and annual audits of the financial statements that were materially misstated. Among other things, each of the defendants submitted management representation letters to the auditors that concealed the fraud and made false statements, which included that the affected quarterly and annual financial statements were presented in conformity with U.S. GAAP and that they had no knowledge of any fraud that could have a material effect on the financial statements. Dunn, Beatty, and Gollogly also submitted a false management representation letter in connection with Nortel’s first restatement, and Pahapill likewise made false management representations in connection with Nortel’s second restatement.

The defendants’ scheme resulted in Nortel issuing materially false and misleading quarterly and annual financial statements and related disclosures for at least the financial reporting periods ending December 31, 2000, through December 31, 2003, and in all subsequent filings made with the SEC that incorporated those financial statements and related disclosures by reference.

On October 15, 2007, Nortel, without admitting or denying the SEC’s charges, agreed to settle the commission’s action by consenting to be enjoined permanently from violating the antifraud, reporting, books and records, and internal control provisions of the federal securities laws and by paying a $35 million civil penalty, which the commission placed in a Fair Fund5 for distribution to affected shareholders.6 Nortel also agreed to report periodically to the commission’s staff on its progress in implementing remedial measures and resolving an outstanding material weakness over its revenue recognition procedures.

On January 14, 2009, Nortel filed for protection from creditors in the United States, Canada, and the United Kingdom in order to restructure its debt and financial obligations. In June, the company announced that it no longer planned to continue operations and that it would sell off all of its business units. Nortel’s CDMA wireless business and long-term evolutionary access technology (LTE) were sold to Ericsson, and Avaya purchased its Enterprise business unit.

The final indignity for Nortel came on June 25, 2009, when Nortel’s stock price dropped to 18.5¢ a share, down from a high of $124.50 in 2000. Nortel’s battered and bruised stock was finally delisted from the S&P/TSX composite index, a stock index for the Canadian equity market, ending a colossal collapse on an exchange on which the Canadian telecommunications giant’s stock valuation once accounted for a third of its value.

Postscript

The three former top executives of Nortel Networks Corp. were found not guilty of fraud on January 14, 2013. In the court ruling, Justice Frank Marrocco of the Ontario Superior Court found that the accounting manipulations that caused the company to restate its earnings for 2002 and 2003 did not cross the line into criminal behavior.

Accounting experts said the case is sure to be closely watched by others in the business community for the message it sends about where the line lies between fraud and the acceptable use of discretion in accounting.

The decision underlines that management still has a duty to prepare financial statements that “present fairly the financial position and results of the company” according to a forensic accountant, Charles Smedmor, who followed the case. “Nothing in the judge’s decision diminished that duty.”

During the trial, lawyers for the accused said that the men believed that the accounting decisions they made were appropriate at the time, and that the accounting treatment was approved by Nortel’s auditors from Deloitte & Touche. Judge Marrocco accepted these arguments, noting many times in his ruling that bookkeeping decisions were reviewed and approved by auditors and were disclosed adequately to investors in press releases or notes added to the financial statements.

Nonetheless, the judge also said that he believed that the accused were attempting to “manage” Nortel’s financial results in both the fourth quarter of 2002 and in 2003, but he added he was not satisfied that the changes resulted in material misrepresentations. He said that except for $80 million of reserves released in the first quarter of 2003, the rest of the use of reserves was within “the normal course of business.” Judge Marrocco said the $80 million release, while clearly “unsupportable” and later reversed during a restatement of Nortel’s books, was disclosed properly in Nortel’s financial statements at the time and was not a material amount. He concluded that Beatty and Dunn “were prepared to go to considerable lengths” to use reserves to improve the bottom line in the second quarter of 2003, but he said the decision was reversed before the financial statements were completed because Gollogly challenged it.

In a surprising twist, Judge Marrocco also suggested the two devastating restatements of Nortel’s books in 2003 and 2005 were probably unnecessary in hindsight, although he said he understood why they were done in the context of the time. He said the original statements were arguably correct within a threshold of what was material for a company of that size.

Darren Henderson, an accounting professor at the Richard Ivey School of Business at the University of Western Ontario, said that a guilty verdict would have raised the bar for management to justify their accounting judgments. But the acquittal makes it clear that “management manipulation of financial statements is very difficult to prove beyond a reasonable doubt in a court of law,” he said.

It is clear that setting up reserves or provisions is still subject to management discretion, Henderson said. “The message . . . is that it is okay to use accounting judgments to achieve desired outcomes, [such as] a certain earnings target.”

___________________

1U.S. District Court for the Southern District of New York, U.S. Securities and Exchange Commission v. Frank A. Dunn, Douglas C. Beatty, Michael J. Gollogly, and Maryanne E. Pahapill, Civil Action No. 07-CV-2058, www.sec.gov/litigation/complaints/ 2007/comp20036.pdf .

2Pro forma means literally as a matter of form. Companies sometimes report income to the public and financial analysts that may not be calculated in accordance with GAAP. For example, a company might report pro forma earnings that exclude depreciation expense, amortization expense, and nonrecurring expenses such as restructuring costs. In general, pro forma earnings are reported in an effort to put a more positive spin on a company’s operations. Unfortunately, there are no accounting rules on just how pro forma should be calculated, so comparability is difficult at best, and investors may be misled as a result.

3Janet McFarland, “Nortel Accounting Reserve Reversal Deemed ‘Reasonable,’” The Globe and Mail,  September 6, 2012, Available at:http://www.theglobeandmail.com/globe-investor/nortel-accounting-reserve-reversal-deemed-reasonable-by-auditors-court-told/article4171550/.

4U.S. SEC v. Nortel Networks Corporation and Nortel Networks Limited, Civil Action No. 07-CV-8851, October 15, 2007, Available at:https://www.sec.gov/litigation/complaints/2007/comp20333.pdf

5A Fair Fund is a fund established by the SEC to distribute “disgorgements” (returns of wrongful profits) and penalties (fines) to defrauded investors. Fair Funds hold money recovered from a specific SEC case. The commission chooses how to distribute the money to defrauded investors, and when completed, the fund terminates.

6Theresa Tedesco and Jamie Sturgeon, “Nortel: Cautionary Tale of a Former Canadian Titan,”Financial Post, June 27, 2009.

QUESTIONS

1. Discuss Nortel’s accounting for the following transactions and why they were not in conformity with GAAP:

-Revenue recognition

-Reserve accounting

-Accounting for contingent liabilities

2. The following two statements are made in the case:

Accounting experts said the case is sure to be closely watched by others in the business community for the message it sends about where the line lies between fraud and the acceptable use of discretion in accounting.

Darren Henderson opined that “The message . . . is that it is okay to use accounting judgments to achieve desired outcomes, [such as] a certain earnings target.”

Evaluate these statements from the perspectives of representational faithfulness and fair presentation of the financial results reported by Nortel.