Mega Enterprises is in the process of negotiating an extension of its existing loan agreements with a

Question:

Mega Enterprises is in the process of negotiating an extension of its existing loan agreements with a major bank. The bank is particularly concerned with Mega's ability to generate sufficient cash flow from operating activities to meet the periodic principal and interest payments. In conjunction with the negotiations, the controller prepared the following statement of cash flows to present to the bank:

Mega Enterprises

Statement of Cash Flows

For the Year Ended December 31, 2017

(all amounts in millions of dollars)

Cash flows from operating activities

Net income ........................................................................................$ 65

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation and amortization ..................................................................56

Increase in accounts receivable ...............................................................(19)

Decrease in inventory ............................................................................27

Decrease in accounts payable ..................................................................(42)

Increase in other accrued liabilities ............................................................18

Net cash provided by operating activities ....................................................$ 105

Cash flows from investing activities

Acquisitions of other businesses ..............................................................$(234)

Acquisitions of plant and equipment ..........................................................(125)

Sale of other businesses ...........................................................................300

Net cash used by investing activities .........................................................$ (59)

Cash flows from financing activities

Additional borrowings ..........................................................................$ 150

Repayments of borrowings .....................................................................(180)

Cash dividends paid ..............................................................................(50)

Net cash used by financing activities .........................................................$ (80)

Net decrease in cash ............................................................................$ (34)

Cash balance, January 1, 2017 ....................................................................42

Cash balance, December 31, 2017 ...............................................................$ 8

During 2017, Mega sold one of its businesses in California. A gain of $150 million was included in 2017 income as the difference between the proceeds from the sale of $450 million and the book value of the business of $300 million. The effect of the sale can be identified and analyzed as follows (in millions of dollars):

Mega Enterprises is in the process of negotiating an extension

As assistant controller, one of your assignments is to review the financial statements prior to their release. When you ask your boss for an explanation of the way in which the sale of the business was reported on the statement of cash flows, he explains that ''the gain is correctly included in net income and that is all that matters.''
Required
Use the Ethical Decision Framework in Exhibit 1-9 to complete the following requirements:
1. Recognize an ethical dilemma: What ethical dilemma(s) do you face? Do you agree with the way in which the controller treated the sale of the business on the statement of cash flows? Explain why you agree or disagree.
2. Analyze the key elements in the situation:
a. Who may benefit if the sale of the business is reported on the statement of cash flows in the manner the controller insists it be reported? Who may be harmed?
b. How are they likely to benefit or be harmed?
c. What rights or claims may be violated?
d. What specific interests are in conflict?
e. What are your responsibilities and obligations?
3. List alternatives and evaluate the impact of each on those affected: As assistant controller, what are your options in dealing with the ethical dilemma(s) you identified in (1) above?
If the sale of the business is reported on the statement of cash flows as the controller insists, will users have reliable information needed to make decisions? Why or why not?
4. Select the best alternative: Among the alternatives, which one would you select?

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