Lola, the CEO of JB Inc., and Frank, the accountant for JB Inc., were recently having a meeting to discuss the upcoming release of the company’s financial statements. Following is an excerpt of their conversation: Lola: These financial statements don’t show the hours of hard work that we’ve put in to restore this company to financial health. In fact, these results may actually prevent us from obtaining loans that are critical to our future.
Frank: Accounting does allow for judgment. Tell me your primary concerns and let’s see if we can work something out.
Lola: My first concern is that the company doesn’t appear very liquid. As you can see, our current assets are only slightly more than current liabilities. The company has always paid its bills—even when cash was tight. It’s not really fair that the financial statements don’t reflect this.
Frank: Well, we could reclassify some of the long-term investments as current assets instead of noncurrent assets. Our expectation is that we will hold these investments for several years, but we could sell them at any time; therefore, it’s fair to count these as current assets. We could also reclassify some of the accounts payable as noncurrent. Even though we expect to pay them within the next year, no one will ever look close enough to see what we’ve done. Together these two changes should make us appear more liquid and properly reflect the hard work we’ve done. Lola: I agree. However, if we make these changes, our long-term assets will be smaller and our long-term debt will be larger. Many analysts may view this as a sign of financial trouble. Isn’t there something we can do?
Frank: Our long-term assets are undervalued. Many were purchased years ago and recorded at historical cost. However, companies that bought similar assets are allowed to record them at an amount closer to their current market values. I’ve always thought this was misleading. If we increase the value of these long-term assets to their market value, this should provide the users of the financial statements with more relevant information and solve our problem, too. Lola: Brilliant! Let’s implement these actions quickly and get back to work.
Required:
Describe any ethical issues that have arisen as the result of Lola and Frank’s conversation.