1. Explain how incrementalism might influence Ricardo's position with respect to the not so subtle statement by Norman Baitz.

“I’m sorry, Lucy. That’s the client's position,” Ricardo said. 

“I just don’t know if I can go along with it, Ricardo,” Lucy replied.

“I know. I agree with you. But, Juggyfroot is our biggest client, Lucy. They’ve warned us that they will put the engagement up for bid if we refuse to go along with the reclassification of marketable securities,” Ricardo explained.

“Have you spoken to Fred and Ethel about this?” Lucy asked.

"They recommended giving in to the client on this matter," Ricardo responded.

"Listen," Lucy said. "I understand the pressures of being an engagement partner and the need to keep the client happy, but this goes too far." 

The previous scene took place in the office of Deziloo LLP, a large CPA firm in Beverly Hills, California. Lucy is the manager of the engagement of Juggyfroot, a publicly owned global manufacturer of pots and pans and other household items. Ricardo is the managing partner of the office. Fred and Ethel are the engagement review partners that make final judgments on difficult accounting issues, especially when there is a difference of opinion with the client. All four are CPAs.

Ricardo is preparing for a meeting with Norman Baitz, the CEO of Juggyfroot. Ricardo knows that the company expects to borrow $5 million next quarter and it wants to put the best possible face on its financial statements to impress the banks. That would explain why the company reclassified a $2 million market loss on a trading investment to the available-for-sale category so that the “loss” would now show up in stockholder’s equity, not as a charge against current income. The result was to increase earnings in 2018 by 8 percent. Ricardo knows that without the change, the earnings would have declined by 2 percent and the company’s stock price would have taken a hit. 

In the meeting, Ricardo decides to overlook the recommendation by Fred and Ethel. He felt Lucy made valid points. Ricardo points out to Baitz that the investment in question was marketable, and in the past, the company had sold similar investments in less than one year. Ricardo adds there is no justification under GAAP to change the classification from trading to available-for-sale.

What happened next shocked Ricardo back to reality. The conversation between Baitz and Ricardo went this way.

“I hate to bring it up, Ricardo, but do you recall what happened last year at about the same time?”

“What do you mean?”

“You agreed that we could record $1 million as revenue for 2017 based on a sale of our product that we held at an off-site distribution warehouse until the client asked for delivery, which occurred in 2018.”

Ricardo remembered all too well. It almost cost the firm the Juggyfroot account. “Are you going to throw that in my face?”

“No, Ricardo. Just a gentle reminder that you had agreed to go along with what we had asked at that time. We believe there is enough gray area to do the same here. Who knows. We may hold on to the investment for more than one year."  

The meeting broke up when Baitz received a confidential phone call. They agreed to continue it first thing in the morning. Baitz's parting words were "we value loyalty in our accountants."