You are hired as a corporate accountant for Ryco Industries, Inc., a public comp

Question

You are hired as a corporate accountant for Ryco Industries, Inc., a public company with shares traded on the New York Stock Exchange. The company has enjoyed consistently higher earnings each quarter, meeting or exceeding the expectations of Wall Street analysts every quarter for the past seven years. Soon after being hired, you discover a “reserve” account in the accounting records. Your inquiry shows that the account is designed to accumulate earnings defi ciencies or excesses, that is, to permit Ryco to adjust its earnings each quarter such that earnings not increase too little or too much. You bring your fi ndings to the attention of Ryco’s chief accounting offi cer, who tells you that the account merely allows Ryco to smooth or manage its earnings, something that Wall Street analysts want to see. If earnings fl uctuated, she explains, analysts would make less optimistic estimates about the prospects of Ryco, and its stock price would take a hit. The CAO tells you, “Look, we’re just doing this to avoid getting hammered in the stock market. Every company does this. And we’re not making up earnings. When actual earnings are too high, we just withhold recognizing some of those earnings until we need them in the future. When actual earnings are too low, we know we’ll have better quarters in the future from which we can borrow earnings now. It all evens out.” Can you identify the critical thinking errors and the characteristics of poor decision making that the CAO is exhibiting? Create a plan that will help you resist the CAO’s request for you to continue to manage earnings as Ryco has done in the past.

Explanation / Answer

Since the CAO is reserving its profit of a given period to settle the same in a quarter where copmany didnot perform well is a clear indication of misstatement and misrepresentation of fact. Due to this misrepresentation Sotck price is also getting affected since it is not showing true picture of ocmpanies performace for a given period of time.

Since this is against basic accounting policy and the practice is very unhealthy.

This can be avoided by freezing the data of reserves once the quarter is closed. The reserve Account which is presently opened separately should be closed and trasnferred to main Profit account and the same shouldbe be allowed for any adjustment.

No entries should be allowed to be passed in it except transfer or profit/loss during the end of a period into that account. No transaction indicating transfer out from that reserve should be allowed except dividend issue, capital redemption and any other managerial decision. The same must be disclosed seprately in its quarterly statemetns.

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