Bricker Graphics is a privately held company specializing in package labels. Rep

Question

Bricker Graphics is a privately held company specializing in package labels. Representatives of the firm have just returned from Switzerland, where a Swiss firm is manufacturing a custom-made high speed, color labeling machine. Confidence is high that the new machine will help rescue Bricker from sharply declining profitability. Bricker's chief operating officer, Don Benson, has been under fire for not reaching the company's performance goals of achieving a rate of return on assets of at least 12%. The afternoon of his return from Switzerland, Benson called Susan Sharp into his office. Susan is Bricker's Controller.

How will Benson's plan affect the return measure?

What accounting issue is involved?

Is the proposal ethical?

Who would be affected if the proposal is implemented?

Explanation / Answer

1) ) If they issue $10 million in stock then profit figure wouldn't be affected so they would have a ROA of 0.88 higher than it should be at 0.85. ( in reality there would be a small cost of issuing the new shares which would effect profit but we shall ignore that here.)

Working notes for the above answer is as under

First of all let we calculate ROA and Return On Assets or ROA is calculated by:

=net income / total assets

So lets assume that,

before this investment, that the net income for Bricker Graphics was $100

and total assets of $100. This isn't very likely in real life but let's keep the numbers simple.

net income/total assets = $100 million / $100 million = 1

If they buy it with debt for $12.5 million (discussed amount) then they would also have to pay for the loan. Lets say they pay $5 million per year over 3 years for the loan.

Then the new ROA would look like this

$100 million profits minus $5 million loan payment / $100 million assets plus new $12.5 million machine

= $95 million / $112.5 million

= 0.84

If they paid for it using equity of $10 million then the figures would look like this,

$100 million in profits / $112.5 million

=0.88

So by using equity it appears that Benson is running the company more efficiently than he really is because the ROA is higher.

3) Is the praposal ethical

Answer :

No this is not ethical.

4)

Who would be affected if the proposal is implemented?

Answer

The shareholders would be effect by creative accounting and Benson would be affected

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