Ethics and Income The Bubble Company has been evaluating operating results for 2001. Things don’t look very good. The company anticipates a small operating loss for the year for the first time in the last 10 years, and the stock price is sure to fall. If this occurs, the officers’ stock options will lose their value, and no one is very happy. Now, the chief accountant reports that the company will have to change the way it records the costs of postemployment benefits for its employees, resulting in another big expense for the company. When the executive committee asks the accountant whether there will be any more such costs, the accountant reluctantly says that, because the economy is slowing, some of the equipment is not being fully utilized and may need to be sold. In addition, the company may have to increase its bad debt expense next year. Also, the experience with warranty costs seems to indicate that the estimated warranty expense may have to be increased next year.

After several hours of debating ways to make changes that would result in a positive return for 2001, the executive committee gives up, concluding that reporting a loss for the year will be inevitable. Now the committee reverses directions and tells the chief accountant to take all possible losses in 2001. Given that the company will have a loss for 2001 anyway, management wishes to increase the bad debt expense this year enough to cover a major portion of bad debt expense for next year. It also wishes to increase the warranty expense so the expense will be higher this year and lower next year and, if possible, to write off some of the old equipment and take the loss this year so there will be no depreciation expense or loss on it next year. In other words, if it is to be a loss year, let’s “take a big bath” this year so we can look better during the next several years.

The proposals made by the executive committee seem to be following conservative accounting practices, recognizing all possible losses.

a. Are the proposals in accordance with generally accepted accounting principles?

b. Are the proposals ethical?

If you were the chief accountant, how would you respond?

d. From a potential investor’s perspective, how do you view the proposed accounting practices? Explain.