Question

Mary Milken is the CFO of the Rbeck Company in Miami, Florida. The company is a closely held custom yacht builder with about 200 technical workers (engineers, marine architects, mechanics, boat workers, and so on), and 12 employees in its main office staff. Her primary job is to prepare the financial statements with the assistance of two full-time accountants. She normally follows generally accepted accounting principles, but she sometimes ignores them when she thinks they do not lead to what she considers best practices for the small number of her company’s shareholders.

In the previous decade, the company was owned by three sisters, each of whom served on the board of directors. One of the three, Vanessa Rbeck, served as the CEO during that period. The other two have always deferred to her with respect to her operational management decisions.

Only a month ago, however, Vanessa’s sisters were killed when their private plane crashed enroute to the Bahamas, which they frequently visited on weekends for relaxation. Upon their death, all of their shares in the Rbeck company transferred to a single trustee in one of the large South Florida banks. Each sister had held her shares in revo- cable living trusts with the same bank named as successor trustee.

As soon as the funerals were over, Mary and Vanessa met with the trustee, Annie Crusher. The meeting did not go well. Annie had grown up working in a family-owned retail boat business, and she thought her knowledge of the industry transferred to the yacht-building business. She began asking Vanessa a rapid succession of unfriendly questions in an adversarial tone of voice. Her questions strongly implied that a yacht- building business did not belong in South Florida but offshore where labor is cheaper. After the meeting, both Mary and Vanessa became afraid that Annie would do some- thing crazy like fire them both or liquidate the business.

For the previous five years, Rbeck’s stock had sold for a steady $12 per share, with $8 per share in dividends. Vanessa received a good salary, but she depended on the dividends to send her children to private schools and to pay the large mortgage on her waterfront home in South Beach. She immediately realized that she was now at Annie’s mercy; she could easily cut off Vanessa’s dividends, lower her salary, or put her out of work.

To make things worse, Mary was almost finished with the most recent annual report, and it appeared that earnings were down for the first time ever. Her preliminary calculations showed earnings per share somewhere near $8.

The problem with earnings had been caused by large bad debts from three clients who had been arrested for drug trafficking. Rbeck had entirely financed luxury yachts for the three clients because of their excellent credit history and prominence in the business community. However, the federal government seized all of the clients’ assets, leaving nothing for Rbeck but the three half-built yachts.

After thinking things over, Vanessa asked Mary to find a way to avoid having to report lower earnings because of her concern as to how Annie might respond to the decline in earnings. Mary considered various options:

•             Increase the estimated percentage of completion on all yachts in work-in-process inventory by 15 percent. This would wipe out most of the loss. Work in process estimates have always been very conservative anyway.

•             Recognize revenue on the three yachts in default. It would be very difficult to sell them at a good price, but she could always argue that they could be sold if she could keep a straight face. The best strategy would be to find new buyers for them, but that could take a couple of years.

•             Switch to mark-to-market accounting for some of the yachts in progress so the company could recognize all of the profit when contracts with other clients are signed.

a. Is any option that Mary is considering acceptable under generally accepted accounting principles? Why or why not?

b. DoanyoftheoptionsbeingconsideredbyMaryconstitutefinancialstatementsfraud?

c. How would you handle the entire situation if you were in Mary’s shoes?

Answer 1

SUMMARY:In this case, Mary Milken serves as the CFO of Rbeck Company, a company that builds yachts based in Miami Florida. Unfortunately, Mary saw potential changes being made in the way that the company currently operates when two of the owners died and a trustee named Annie Crusher was brought in. Due to Annie’s prior experience in working with a family owned boat business she began to ask questions that would imply that Rbeck Company should located off shore where labor is more affordable than in South Florida. In efforts to make sure that their jobs were secure, they attempted to come up with a plan that would provide an acceptable explanation as to why there is a dramatic decrease in earnings. The cause for the problems in the company is that they have three clients that had their yachts financed by Rbeck to be arrested for drug trafficking.

A)Mary came up with 3 solutions, and of the three, the one that I find the most beneficial would be to convince Annie that the yachts could be sold to another customer at a lower price. I think that this would be a viable solution, because due to the fact that the three yachts are only half way built it may be easy to find others that are interested in purchasing those yachts at discounted rates. I think that a deal such as this would be appealing to customers, because they would be able to customize the remaining part of the yacht that has to be completed. Even though it may take a few years to find new buyers that are financially able to make such a large purchase. However even if Mary and Vanessa were able to find buyers for the three yachts within the next few years. The sales will not be recorded in this year’s financial records

B)I believe only one of the options Mary is considering is considered financial statements fraud. This would be that she is considering increasing the percentage of completion on all the yachts that are a work in progress. This is financial fraud because it increases the amount of on hand inventory to be sold that is technically not available for sale yet

C)If I was in this situation, I would have simply dealt with the consequences of Annie finding out about the decrease in earnings. The worst thing that can happen is she gets fired. It is evident that Annie feels the company should be located offshore, hopefully results such as these would cause Annie to move the company to a new location and outsource labor. The move can result in lower overhead and higher profits for the company. Also they can elect to use mark to marketing accounting. This will allow them to fully tax deduct any losses they incur.