Redcliffe company is a fertilizer manufacturer. Its sales declined greatly this

Question

Redcliffe company is a fertilizer manufacturer. Its sales declined greatly this year due to the passage of legislation outlawing the sale of several Redcliffe’s chemical fertilizers. In the coming year, Redcliffe will have environmentally safe and competitive chemicals to replace these discontinued products. Sales in the next year are expected to greatly exceed any prior year’s. The decline in sales and profits appears to be a one-year aberration. But even so, the company president fears a large dip in the current year’s profits. He believes that such a dip could cause a significant drop in the market price of Redcliffe’s stock and make the company a takeover target.

To avoid this possibility, the company calls in Stacy Clark, controller, to discuss this period’s year-end adjusting entries. He urges her to accrue every possible revenue and to defer as many expenses as possible. He says to Stacy, “We need the revenues this year, and next year can easily absorb expenses deferred from this year. We can’t let our stock price be hammered down!” Stacy didn’t get around to recording the adjusting entries until January 15, but she dated the entries December 31 as if they were recorded then, Stacy also made every effort to comply with the president’s request.

In 200 words or less, provide the ethical considerations, if any, of (1) the president’s request and (2) Stacy’s dating the adjusting entries December 31?

Explanation / Answer

The President is trying to shore up Redcliffe's topline (revenues) as well as bottomline (profits) for this year, to avoid a fall in the company's share price. He is trying to achieve this by accruing every possible revenue. Accrued revenue is a sale that has been recognized by the seller, but which has not yet been billed to the customer. The adjusting entry for accrued revenue will be : Debit the Accrued revenue and credit the sales account.

This seems to be unethical, as the company sells fertilizers, a physical and tangible goods. Revenue will be recognized and billing will be done immediately when the sales are completed. By asking Stacy to make adjusting entry for accrued revenue, president is implying that she should book future orders as sales. This, however, is not ethical as orders are different from sales. However, the president is telling Stacy to accrue only "possible" revenues. So, on the face of it, only those revenues will be accrued that is actually accrued - i.e sales have been made, but billing is not done. For example, company is selling ferilizers for a tender in parts. The billing will be done next year, but the part delivery has started. This is a "possible" revenue and hence is ethical.

Deferring an expense means that payment for the expense has been done but it will be reported as an expense in a future accounting period. Deferring is done to achieve the matching principle. If the principle is followed and adhered, there is nothing wrong with it.

But if Stacy makes adjusting entries for revenue and expenses with the sole purpose of dressing up the books and not following the accounting principles, then it will be unethical.

As far as the dates of the adjusting entries is concerned, they should have been made on the last day of the accounting period i.e on December 31st. This is done to incorporate the matching principle. Stacy's dating the adjusting entries is clearly unethical, as the entries have been done at a later date to achieve a purpose, rather than follow accounting principles.

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