Ethics: Changes in Estimate Mike Crane is an audit senior of a large public acco

Question

Ethics: Changes in Estimate

Mike Crane is an audit senior of a large public accounting firm who has just been assigned to the Frost Corporation’s annual audit engagement. Frost has been a client of Crane’s firm for many years. Frost is a fast-growing business in the commercial construction industry. In reviewing the fixed asset ledger, Crane discovered a series of unusual accounting changes, in which the useful lives of assets, depreciated using the straight-line method, were substantially lowered near the midpoint of the original estimate. For example, the useful life of one dump truck was changed from 10 to 6 years during its fifth year of service. Upon further investigation, Mike was told by Kevin James, Frost’s accounting manager, “I don’t really see your problem. After all, it’s perfectly legal to change an accounting estimate. Besides, our CEO likes to see big earnings!”

Answer the following questions in the Discussion Board:

What are the ethical issues concerning Frost’s practice of changing the useful lives of fixed assets?

Who could be harmed by Frost’s unusual accounting changes?

What should Crane do in this situation?

Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2016). Accounting changes and error analysis. Intermediate accounting (16th ed.). (p. 1323). New York, NY: John Wiley & Sons, Inc.

Explanation / Answer

a. When the accounting team changes the useful life of a series of assets it could be an indication that the depreciation expenses in the prior years were understated. The ethical issues and corcerns are that although an organization has the right to change accounting estimates if they are doing so to intentionally mislead investors it is unethical. Users of the financial statements can not rely on the information as it appears that it is being manipulated. I think that further investigation would need to be done to ascertain if the CEO knows what the accounting manager is doing in an attempt to give the appearance that earnings are greater than what they are, or if this is something that the accounting manager is doing independently.

b. The primary stakeholders that could be harmed by Frost's unusual accounting changes are Frost's shareholders and creditors because these accounting changes make it appear that the organization has more earnings than it actually does. Creditors could have extended more credit to the organization than they would have if they the organizations actual earnings. Investors may have invested in more the organization thinking it was more profitable than it was. The auditing firm that Crane works for can also be harmed by Frost's depreciation accounting practices because they are now aware of irregularities. If they do not act appropriately they can be viewed as if they were complicit. This would lead to damage of the organizations reputation and loss of business.

c. Crane should report his findings to senior management of his organization. After reviewing his findings if they feel there is evidence of fraudulent behaviour they are professionally obligated to report their findings to the Audit Committee of the Board of Directors of Frost.

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