Question

M. K. Gallant is president of Kranbrack Corporation. A company whose stock is traded on a national exchange. In a meeting with investment analysts at the beginning of the year, Gallant had predicted that the company’s earnings would grow by 20% this year. Unfortunately, sales have been less than expected for the year, and Gallant concluded within two weeks of the end of the fiscal year that it would be impossible to report an increase in earnings as large as predicted unless some drastic action was taken. Accordingly, Gallant has ordered that wherever possible, expenditures should be postponed to the new year-including cancelling or postponing orders with suppliers, delaying planned maintenance and training, and cutting back on end-of-year advertising and travel. Additionally, Gallant ordered the company’s controller to carefully scrutinize all costs that are currently classified as period costs and reclassify as many as possible as product costs. The company is expected to have substantial inventory at the end of the year.

Please answer the following questions:

1. Identify the potential impact on financial statements 2. Identify the relevant stakeholders of a situation. Who are the relevant stakeholders (persons or groups with a legitimate interest) in this situation? 3. Do you think the companies conduct is ethical? Explain your response.. Describe the issues, if any, which may potentially violate ethical principles

Answer 1

Potential Impact on Financial Statements

The chief of the company wants to inflate the company's earnings through unethical accounting treatments. This will affect the company's financials and as well as cause difficulties among various stakeholders of the company at macro level.

First of all let us analyze the course of actions suggested by the chief and impact of the same upon the financials of the company.

1. Delaying and postponing expenses

Delaying planned maintenance and postponing expenditure will cause major setback on the operational side as well as cause great impact over the financials. The profit for the current period will be unduly inflated and also it will cause excessive expenditure for the next period thereby causing reduced profit or even loss in the next accounting period.

2. Classifying period cost as product cost

The closing inventory is valued at cost and while classifying period cost as product cost, cost of the closing inventory will be inflated and will contribute to inflated profit. This will also cause inflated opening inventory in the next accounting period and thereby cause reduced profit or loss in the next accounting period.

In fact with both measures, company is not adding any value to itself or to any stake holders but simply recognizing profit early through unethical accounting treatment.

The accounting treatment should be objective and as per approved standards, rather than subjective upon required outcome as per the whims and wishes of the management. Then only the stakeholders could rely upon the financial statements and make informed decisions.

Stakeholders being affected:

• Shareholders will be happy to have increased earnings in the current period but will be disappointed in the next year.
• Suppliers who has been denied orders part of suspension of purchase orders will be impacted.
• Customers will lose the trust on the ethical values of the company if this has been reveled in future.
• Employees will lose morale
• Operations might have come to halt due to lack of Maintenance.
• Tax Authorities may initiate probe into inconsistent behavior of profit.
• Inflated profits of this company will disrupt the stock value of the similar players from the industry as this will impact the average returns of the industry.
• Society as whole get a wrong picture about the performance of the company.

The company's act is not ethical

The window dressing done by the company to defer cost and increase inventory value is not adding any real value to the stake holders of the company. The measures adopted by the chief are just inflating returns for the current period in the financials and it cannot be considered as ethical.