This case involves a small public traded company named Nebobites, which manufactures dog treats. Jenny O. , CPA, is the new Assistant Controller for the Nebobites’ company, and her job is to review and audit the financial statements for the 2012 year. While reviewing the financial statements, Jenny noticed the company’s Allowance for Doubtful Accounts balance seemed significantly higher than in the past. This increase in the Allowance account was due to the Bad Debt Expense estimation being based off 3% of net credit sales instead of the prior years’ estimate of 1. %. The increase in Bad Debts expense as a result of the increase in estimate materially affected the 2012 earnings. However, 2012 had been a great year for earnings, so the additional expense did not disturb the earnings growth trend Nebobites’ had experienced in the past. However, upon further research, Jenny could find no justification for the increase in the Bad Debt Expense estimate from 1. 5% of net credit sales to 3%. Jenny decides to approach her boss, the Controller, Maxwell Devious.
He tells Jenny he is aware of the practice known as “income smoothing. Maxwell Devious says showing a steady growth in earnings was essential to keep the Nebobite stock price high as possible as the Smith family planned to sell-off a significant number of shares in early 2014. Jenny feels extremely uncomfortable with this practice, and she knows that this year’s financial statements will retain an overstated Bad Debt Expense estimate and more than likely result in an understated Bad Debt Expense estimate in 2013. 2. An ethical decision must be made by Jenny, because she is going to have to decide what is morally right or wrong.
This fake presentation of increase in earnings will potentially affect every stakeholder involved with the company including their shareholders, creditors, management, employees and the customers. This faulty practice will leave an overstated Bad Debt Expense estimate for the year and more than likely result in an understated Bad Debt Expense estimate in 2013. Jenny needs to decide whether she thinks it is more important to look profitable to investors and appear to have greater wealth or is it more important to show creditors that they do not have sufficient funds to cover their debts.
She also knows that Maxwell Devious, the Controller, has an employee profit sharing plan, a management bonus plan based on earnings, significant bank loans outstanding and is planning on raising funds through a bond issue in 2014; all of these are affected by the earnings for the year. 3. By deciding not to change the estimate back to the appropriate percentage of 1. 5%, it does single out individuals and the upper management group.
These individuals that are Jenny’s superiors simply do not want her to make the adjustment because it is in their best interest (looking profitable & performance bonuses) and not in the company and its stakeholders’ best interest as a whole. It is also a legal violation because the company’s CEO and other top-level personnel should swear that all financial data for the company is relevant and accurate, and they knowingly defy corporate policies and the GAAP. 4. In this particular situation, Jenny is faced with a couple options; some of which are favorable, others not so much.
Jenny can choose to abide by her scandalous boss, and decide to go along with the inappropriate change in estimate. This choice may blow over for the time being, but in the long run, Jenny and the company may be audited in the future exploiting their mistakes made in the 2012 financial statements. This could cause Jenny to be immediately terminated when the mistakes were finally found, as well as the possibility of jail time after an investigation and trial. Another possible route Jenny could take would be to report the inappropriate practices to an outsider’s attention, such as an external auditing firm.
By doing so, she could save her job possibly for the time the company is being investigated, but may later be fired. Although she will eventually have to find a new job, this choice may save her from being in trouble with the law and potentially boost her chances of finding a new job due to her discovery at Nebobites. Another final option that I would see plausible in this situation would be to simply quit, if the Controller did not want to change the estimation and swear on the financial statements.
The legal risk is too high in the case, and you do not want the downfall of Nebobites to be on your shoulders. 5. By deciding to go along with the inappropriate change in estimate, Jenny’s job may be safe for the time being, but in the long run, Jenny and the company may be audited in the future exploiting their mistakes made in the 2012 financial statements. This could cause Jenny to be immediately terminated when the mistakes were finally found, as well as the possibility of jail time after an investigation and trial.
This is morally and legally wrong because she knowingly goes against corporate policies and the generally accepted accounting principles in order to reap the benefits. By reporting the inappropriate practices to an outsider’s attention, such as an external auditing firm, she could save her job possibly for the time the company is being investigated, but may later be fired. Although she will eventually have to find a new job, this choice may save her from being in trouble with the law and potentially boost her chances of finding a new job due to her discovery at Nebobites.
By choosing this option, Jenny acts in a dignified and legal manner. She knows that she is doing what is right and is protecting stakeholders of the company. The other option of simply just resigning or quitting her position would not have much effect on the company. She is acting morally because she is not going along with the inappropriate practices of Nebobites, but she is not doing what is in the best interest for all stakeholders. The company will most likely find a new Assistant Controller for the operation who will go along with the unlawful scheme.
This ultimately resulting in the downfall of the company, when Jenny could have prevented this and saved thousands of jobs by alerting an outside auditor. 6. By alerting an outside auditor to investigate this situation, Jenny does what is in the best interest for all stakeholders. This will eventually reveal the truth and allow shareholders to see the negative affect on stock prices, creditors can be informed on the debt situation of our company and be aware of the risk of dealing with us.
Management will be disappointed with the actions of Jenny, in which they sacrificed their performance bonuses and will most likely fire her. The company will still have a chance to flourish, however, when the economy turns back around. By keeping the inappropriate estimate, Jenny will most likely be in the praises of her superiors for the bonuses they received; but, in the longer run, the company’s financial statements will be inaccurate and liabilities to creditors will go unpaid.
Shareholders will actual lose more money and the company has the potential to go bankrupt any day if the economy does not take a sudden turn around. The top executives, as well as Jenny, should live in fear of being exploited of their misinterpretations and eventually will get caught up in severe legal trouble. If Jenny simply quit without seeking outside assistance from auditors, she is still acting in a somewhat immoral and illegal manner. This is because the stakeholders of the company will inevitably still be in serious trouble due to the deception of Jenny and the upper management of the Nebobites’ company. . I believe that it is in the best interest for Jenny to consult an outside auditing firm. Although it could potentially make her lose her job when her superiors are notified, it enlightens all stakeholders involved with the Nebobites’ company. The risk is too great if Jenny decides to leave the inappropriate estimate as is; she risks not only losing her job, but also risks going to jail, as well as losing her CPA license entirely. It is worth far more in life to be an honest and truthful person who looks out for others than it is to be a deceitful and uncaring.