Deacon Publishing House is a publishing company that produces consumer magazines

Question

Deacon Publishing House is a publishing company that produces consumer magazines. The house and home division, which sells home-improvement and home-decorating magazines, has seen a 20% reduction in operating income over the past nine months, primarily due to the recent economic recession and the depressed consumer housing market. The division's Controller, Todd Allen, has felt pressure from the CFO to improve his division's operating results by the end of the year. Allen is considering the following options for improving the division's performance by year-end: Cancelling two of the division's least profitable magazines, resulting in the layoff of twenty-five employees. Selling the new printing equipment that was purchased in January and replacing it with discarded equipment from one of the company's other divisions. The previously discarded equipment no longer meets current safety standards. Recognizing unearned subscription revenue (cash received in advance for magazines that will be delivered in the future) as revenue when cash is received in the current month (just before fiscal year end) instead of showing it as a liability. Reducing the division's Allowance for Bad Debt Expense. This transaction alone would increase operating income by 5%. Recognizing advertising revenues that relate to January in December. Switching from declining balance to straight line depreciation to reduce depreciation expense in the current year. What are the motivations for Allen to improve the division's year-end operating earnings? From the point of view of the "Standards of Ethical Behavior for Practitioners of Management Accounting and Financial Management," Exhibit 1-7 on page 38. which of the preceding items (a-f) are acceptable? Which are unacceptable? What should Allen do about the pressure to improve performance?

Explanation / Answer

1. As the controller of house and home division, Allen is responsible and accountable for the operating result of his division. Usually, variable part of salary like the bonus is tied to performance and hence Allen is under pressure to control the deteriorating financial condition of his division. Also, there is pressure from the CFO as the CFO is responsible for the overall financial health of the company.

2. The following items are acceptable - (a) the least profitable magazines can be cancelled. This is ethical as well as prudent and rational business decision. Magazines that are not adding value can be cancelled and the company should only focus on magazines that generate positive cash flows and add value.

(f) depreciation method can be changed for current assets. However, the cumulative effect of changes on past income statements must be reflected on the current income statement.

The following items are unacceptable: (b) new equipment should not be sold as it will result in compromising with the safety standards. This may endanger the lives of its workers.

(c) Unearned subscriptions are liabilities and they cannot be shown as revenues, till the time revenue generation process is completed. This is the principle for accrual basis for accounting.

(d) Bad debt allowances are determined on the basis of risk classification of the receivables. Unless and until there is a material and substantial change in the risk profile of the cutomers, the allowances cannot be changed, just for the sake of decreasing loss.

(e) Again, this is not acceptable. The revenue for Januray will have to be recognized in that month itself. If the revenue is received before hand, then it will stand as a liability.

3. Allen should simply close and cancel those magazines that are not profitable or are least profitable. Allen can do a pareto analysis of the different magazines and can then consider those divisions at the bottom of pareto table. These magazines will be either unprofitable or would be having very low profits. Closing these magazines will ensure that no division or magazine are now eroding the overall operating income of the company.

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