This questionnaire includes short descriptions of severalearnings management practices. Please indicate your judgment as tothe acceptability of these practices using the following scale:
1 – Ethical practice.
2 – Questionable practice. I would not say anything to themanager, but it makes me uncomfortable.
3 – Minor infraction. The manager should be warned not to engagein that practice again.
4 – Serious infraction. The manager should be severelyreprimanded.
5 – Totally unethical. The manager should be fired.
(Assume that the division is part of a $1.5 billion (sales)corporation, which has a January-December fiscal year. The divisionhas annual sales of approximately $150 million, with annualbefore-tax operating profit of approximately $18 million.) For eachquestion (or part of a question) circle the number that bestdescribes your judgment regarding the practice. Answer eachquestion separately. (Assume the incidents are independent.) Allindividual responses are confidential
1. The division’s buildings were scheduled to be painted in2008. Since the divisions’ profit was way ahead of budget in 2007,however, the general manager (GM) decided to have the work done in2007. Amount $225,000.
2a. (2) The GM ordered all division employees to defer alldiscretionary expenditures (e.g., travel, advertising, hiring,maintenance) into the next accounting period so that his divisioncould make its budgeted profit targets. Expected amount of thedeferral: $225,000. The expense was postponed from February andMarch until April in order to make the first quarter target.
2b. (3) The GM ordered all division employees to defer alldiscretionary expenditures (e.g., travel, advertising, hiring,maintenance) into the next accounting period so that his divisioncould make its budgeted profit targets. Expected amount of thedeferral: $225,000. The expense was postponed from November andDecember until January in order to make the annual target.
3. (4) On December 15, a clerk in the division placed an orderfor $4,500 worth of office supplies, and the supplies weredelivered on December 29. This order was a mistake because thedivision GM had ordered that no discretionary expenses be incurredfor the remainder of the fiscal year, and the supplies were noturgently needed. The company’s accounting policy manual states thatoffice supplies are to be recorded as an expense when delivered.The division GM learned what had happened, however, and to correctthe mistake, he ordered the accounting department not to record theinvoice until February.
4a. (5) In September, the GM realized that the division wouldneed strong performance in the last quarter of the year in order toreach its budget targets. The GM decided to implement a salesprogram offering liberal payment terms to pull some sales thatwould normally occur next year into the current year; customersaccepting delivery in the 4th quarter would not have to pay theinvoice for 120 days.
4b. (6) In September, the GM realized that the division wouldneed strong performance in the last quarter of the year in order toreach its budget targets. The GM ordered manufacturing to workovertime in December so that everything possible could be shippedby the end of the year.
4c. (7) In September, the GM realized that the division wouldneed strong performance in the last quarter of the year in order toreach its budget targets. The GM sold some excess assets andrealized a profit of $40,000
5a. (8) At the beginning of December 2007, the GM realized thatthe division would exceed its budgeted profit targets for the year.The GM ordered the division’s controller to prepay some expenses(e.g., hotel rooms, exhibit expense) for a major trade show to beheld in March 2008 and to book them as a 2007 expense. Amount$90,000.
5b. (9) At the beginning of December 2007, the GM realized thatthe division would exceed its budgeted profit targets for the year.The GM ordered the division’s controller to develop the rationalefor increasing the reserve for inventory obsolescence. By taking apessimistic view of future market prospects, the controller wasable to identify $1,050,000 worth of finished goods thatconservative accounting would say should be fully reserved (i.e.,written-off), even though the GM was fairly confident the inventorywould still be sold at a later date at close to full price.
6a. (10) The next year, the division described in Question 5b(9) sold 70% of the written-off inventory, and a customer hadindicated some interest in buying the rest of the inventory thefollowing year. The GM ordered the division controller to preparethe rationale for reducing the reserve for obsolescence by $315,000(i.e., writing up the previously written-off goods to full cost).The GM’s motivation for recapturing the profit was to be able tocontinue working on some important product development projectsthat might have had to be delayed due to budget constraints.
6b. (11) The next year, the division described in Question 5b(9) sold 70% of the written-off inventory, and a customer hadindicated some interest in buying the rest of the inventory thefollowing year. The GM ordered the division controller to preparethe rationale for reducing the reserve for obsolescence by $315,000(i.e., writing up the previously written-off goods to full cost).The GM’s motivation for recapturing the profit was to make budgetedprofit targets.
7. (12) In July 2007 the GM noticed that scrap costs in theplant were running way ahead of plan. So that senior managementwould not become alarmed, the GM ordered the division controller to“bury” most of the scrap costs in other expense accounts where theywould not be noticed. Over the remainder of the year, thecontroller buried approximately $90,000 of scrap costs. Effect onnet income: zero.
8a. (13) In November 2007, the division was straining to meetbudget. The GM called the engagement partner of a consulting firmthat was doing some work for the division and asked that the firmnot send an invoice for work done until next year. The partneragreed. The estimated cost of work done but not invoiced was$45,000.
8b. (14) In November 2007, the division was straining to meetbudget. The GM called the engagement partner of a consulting firmthat was doing some work for the division and asked that the firmnot send an invoice for work done until next year. The partneragreed. The estimated cost of work done but not invoiced was$750,000.
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