CASE: Evaluating an Ethical Dilemma: A Real-Life Example Assume you work as a st

Question

CASE: Evaluating an Ethical Dilemma: A Real-Life Example

Assume you work as a staff member in a large accounting department for a multinational public company. Your job requires you to review documents relating to the company’s equipment purchases. Upon verifying that purchases are properly approved, you prepare journal entries to record the equipment purchases in the accounting system. Typically, you handle equipment purchases costing $100,000 or less.

This morning, you were contacted by the executive assistant to the chief financial officer (CFO). She says that the CFO has asked to see you immediately in his office. Although your boss’s boss has attended a few meetings where the CFO was present, you have never met the CFO during your three years with the company. Needless to say, you are anxious about the meeting.

Upon entering the CFO’s office, you are warmly greeted with a smile and friendly handshake. The CFO compliments you on the great work that you’ve been doing for the company. You soon feel a little more comfortable, particularly when the CFO mentions that he has a special project for you. He states that he and the CEO have negotiated significant new arrangements with the company’s equipment suppliers, which require the company to make advance payments for equipment to be purchased in the future. The CFO says that, for various reasons that he didn’t want to discuss, he will be processing the payments through the operating division of the company rather than the equipment accounting group. Given that the payments will be made through the operating division, they will initially be classified as operating expenses of the company. He indicates that clearly these advance payments for property and equipment should be recorded as assets, so he will be contacting you at the end of every quarter to make an adjusting journal entry to capitalize the amounts inappropriately classified as operating expenses. He advises you that a new account, called Prepaid Equipment, has been established for this purpose. He quickly wraps up the meeting by telling you that it is important that you not talk about the special project with anyone. You assume he doesn’t want others to become jealous of your new important responsibility.

A few weeks later, at the end of the first quarter, you receive a voicemail from the CFO stating, “The adjustment that we discussed is $771,000,000 for this quarter.” Before deleting the message, you replay it to make sure you heard it right. Your company generates over $8 billion in revenues and incurs $6 billion in operating expenses every quarter, but you’ve never made a journal entry for that much money. So, just to be sure there’s not a mistake, you send an e-mail to the CFO confirming the amount. He phones you back immediately to abruptly inform you, “There’s no mistake. That’s the number.” Feeling embarrassed that you may have annoyed the CFO, you quietly make the adjusting journal entry.

For each of the remaining three quarters in that year and for the first quarter in the following year, you continue to make these end-of-quarter adjustments. The “magic number,” as the CFO liked to call it, was $560,000,000 for Q2, $742,745,000 for Q3, $941,000,000 for Q4, and $818,204,000 for Q1 of the following year. During this time, you’ve had several meetings and lunches with the CFO where he provides you the magic number, sometimes supported with nothing more than a Post-it note with the number written on it. He frequently compliments you on your good work and promises that you’ll soon be in line for a big promotion.

Despite the CFO’s compliments and promises, you are growing increasingly uncomfortable with the journal entries that you’ve been making. Typically, whenever an ordinary equipment purchase involves an advance payment, the purchase is completed a few weeks later. At that time, the amount of the advance is removed from an Equipment Deposit account and transferred to the appropriate equipment account. This hasn’t been the case with the CFO’s special project. Instead, the Prepaid Equipment account has continued to grow, now standing at over $3.8 billion. There’s been no discussion about how or when this balance will be reduced, and no depreciation has been recorded for it.

Just as you begin to reflect on the effect the adjustments have had on your company’s fixed assets, operating expenses, and operating income, you receive a call from the vice president for internal audit. She needs to talk with you this afternoon about “a peculiar trend in the company’s fixed asset turnover ratio and some suspicious journal entries that you’ve been making.”

Now answer to the questions presented in the Discussion Board.

Epilogue: This case is based on a fraud committed at WorldCom (now called Verizon). The case draws its numbers, the nature of the unsupported journal entries, and the CFO’s role in carrying out the fraud from a report issued by WorldCom’s bankruptcy examiner. Year 1 in this case was actually 2001 and Year 2 was 2002. This case excludes other fraudulent activities that contributed to WorldCom’s $11 ­billion fraud. The 63-year-old CEO was sentenced to 25 years in prison for planning and executing the biggest fraud in the history of American business. The CFO, who cooperated in the investigation of the CEO, was sentenced to five years in prison.

Source: Financial Accounting- Libby Libby 9 ED (CP 8-7)

QUESTIONS TO ANSWER

1.     Complete the excel table on D2L to determine what the company’s accounting records would have looked like had you not made the journal entries as part of the CFO’s special project. How has the decision to capitalize amounts, which were initially recorded as operating expenses, affected the level of income from operations in each quarter?

Amounts in millionsof US dollars

With the entries

2.     Using the given “with the entries” numbers, compute the fixed asset turnover ratio (rounded to two decimal places) for the periods ended Q2–Q4 of year 1 and Q1 of year 2. Is the ratio increasing or decreasing over time? What does the trend in this ratio suggest to you? Does this trend match the change in operating income over time as well?

3.     Before your meeting with the vice president for internal audit, you think about the above computations and the variety of peculiar circumstances surrounding the “special project” for the CFO. What types of peculiar circumstances do you see surrounding the special project?

4.     Your meeting with internal audit was short and unpleasant. The vice president indicated that she had discussed her findings with the CFO before meeting with you. The CFO claimed that he too had noticed the peculiar trend in the fixed asset turnover ratio, but that he hadn’t had a chance to investigate it further. He urged internal audit to get to the bottom of things, suggesting that perhaps someone might be making unapproved journal entries. Internal audit had identified you as the source of the journal entries and had been unable to find any documents that approved or substantiated the entries. She ended the meeting by advising you to find a good lawyer. How should you have handled the situation with the CFO in order to avoid your lawsuit?

5.     In the real case on which this one is based, the internal auditors agonized over the question of whether they had actually uncovered a fraud or whether they were jumping to the wrong conclusion. The Wall Street Journal mentioned this on October 30, 2002, by stating, “it was clear . . . that their findings would be devastating for the company. They worried about whether their revelations would result in layoffs. Plus, they feared that they would somehow end up being blamed for the mess.” Beyond the personal consequences mentioned in this quote, what other groups could be affected by the findings of the internal auditors and how would the findings potentially affect them?

Amounts in millionsof US dollars

Q1 Year 1 (March 31) Q2 Year 1 (June 30) Q3 Year 1 (Sept 30) Q4 Year 1 (December 31) Q1 Year 2 (March 31) With the entries Without entries   With the entries Without entries

With the entries

Without entries With the entries Without entries With the entries Without entries Prop, plant and equipment $38,614 $ $35,982 $ $38,151 $ $38,809 $ $39,155 $ Sales revenues $8,825 $8,825 $8,910 $8,910 $8,966 $8,966 $8,478 $8,478 $8,120 $8,120 Operating expenses $7,628 $8,526 $7,786 $7,725 $7,277 Income from operations $1,197 $384 $1,180 $753 $843 Q1 Year 1 Q4 Year1 Q2 Year 1 Tune 30) Q3 Year1 (September 30 (December 31) Q1 Year2 March 31) March 31) With WithoutWith WithoutWith Without With WithoutWith Without (amounts in millions the the the the the the the the the the of US. dollars Entries Property and Entries Entries Entries Entries Entries Entries Entries Entries Entries S38.614 S 8,825 7,628 $38,151 s 7,786 1,180 $38,809 $ $39,155S $35,982 $ 8,526 384 ment, net 8,966 8,478 7.725 8,4788,120 8.1 7.277 Sales revenues 8,8258,910 8,910 8,966 expenses Income from operations 1,197 753 843

Explanation / Answer

2. From the Fixed asset turnover ratios calculated above it is clear that the asset turnover is decreasing every year, from 0.24 to 0.21, in second year quarter1. It is also observed that the operating income is decreasing in every quarter, Hence it may be that the company is overinvestedin fixed assets. Need to take care of it.

3. About the special project: Since the CFO has already said that no one has any knowledge about the special project, hence no one has any idea why and how the magic number is increasing and growing bigger. It is still mysterious about the number, how he got it or what formula or method is used to come to this number.

4. As a matter of fact that, anything suspecious have to be disclosed to the auditor. So that if there is anything mischievious or fishy could be identified and brought to attention. Also it has to be disclosed as to how the manager misguided and asked you to do.

.

Amounts in millionsof US dollars Q1 Year 1 (March 31) Q2 Year 1 (June 30) Q3 Year 1 (Sept 30) Q4 Year 1 (December 31) Q1 Year 2 (March 31) With the entries Without entries   With the entries Without entries With the entries Without entries With the entries Without entries With the entries Without entries Prop, plant and equipment $38,614 $37,843 $35,982 $34,567 $38,151 $36,077 $38,809 $35,794 $39,155 $35,322 Sales revenues $8,825 $8,825 $8,910 $8,910 $8,966 $8,966 $8,478 $8,478 $8,120 $8,120 Operating expenses $7,628 8400 $8,526 9,076 $7,786 8429 $7,725 8657 $7,277 8089 Income from operations $1,197 326 $384 -166 $1,180 537 $753 -179 $843 31 ** The computation of book value of property plant and equipment is carried from year to year, so computation of book value without entries will take into considerations cumulative effect of entries: Q1 Year 1 (March 31) $38,614 - $771 = $37,843 Q2 Year 1 (June 31) $35982 - $771 - $560 = $34,651 Q3 Year 1 (Sept 30) $38151 - $771 - $560 - $743 = $36,077 Q4 Year 1 (December 31) $38809 - $771 - $560 - $743 - $941 = 35794 Q1 Year 2 (March 31) $39155 - 771 - 560 - 743 - 941 - 818 = $35,322 Q2 Year 1 Q3 Year 1 Q4 Year 1 Q1 Year 2 Average Fixed Assets = FA of Previous Q/FA of This Q 37298 37066.5 38480 38982 Fixed Asset Turnover Ratio = Net Sales/Average net fixed assets 8910/37298 8966/37067 8478/38480 8120/38982 = 0.24 0.24 0.22 0.21

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.