59.4 Ethical Decision Making: A Real-Life Example LO 9-22.978 Assure you work as a staff member in a large accounting department for a multinational public company Your job requires you to review documents relating to the company's equipment purchases. Upon verifying that purchases are properly approved, you prepare journal entries to record the equipment purchases in the accounting system. Typically, you hanille equipment purchases costing S100,000 or less This morning, you were contacted by the executive assistant to the chief financial officer (CFO) She says that the CFO has asked to see you immediately in his office. Although your boss's bois han attended a few meetings where the CFO was present, you have never met the CFO during your three years with the company, Needless to say, you are anxious about the meeting Upon entering the CFO's office, you are warmly greeted with a smile and friendly handshake. The CFO compliments you on the great work that you've been doing for the company. You soon feel a little more comfortable particularly when the CFO mention that he has a special project for you. He states that he and the CEO have negotiated significant new arrangements with the company's equipment suppliers, which require the company to make advance payment for equipment to be purchased in the future. The CFO says that, for various reasons that he didn't want to discus, he will be processing the payments through the operating division of the company rather than the equipment accounting group. Given that the payments will be made through the operating division, they will initially he classified as operating expenses of the company. He indicates that clearly these advance payments for property and equipment should be recorded as assets, to he will be contacting you at the end of every quarter to make an adjusting journal entry to capitalize the amounts inappropriately classified as operating expenses. He advises you that a new account, called Prepaid Equipment, has been established for this purpose. He quickly wraps up the meeting by telling you that it is important that you not talk about the special project with anyone. You assume he doesn't want others to become jealous of your new important responsibility A few weeks later ar the end of the first quarter, you receive a voicemail from the CFO stating. "The adjustment that we discussed is 5771.000.000 for this quarter" Before deleting the message, you replay it to make sure you heard it right Your company generates over 8 billion in revenues and incurs S6 billion in operating expenses every quarter, but you've never made a journal entry for that much money. So just to be sure there's not a mistake, you send an e-mail to the CFO confirming the amount. He phones you back immediately to abruptly inform you. "There's no mistake That's the number" Feeling embarrassed that you may have annoyed the CFO, you quietly make the adjusting journal entry, For each of the remaining three quarters in that year and for the first quarter in the following year, you continue to make these and of-quarter adjustments. The magic number" as the CFO liked to call it was $360,000.00 for Q2.5742,745,000 for Q3. $941.000.000 for Q4, and $818.204,000 for Q1 of the following year. During this time, you've had several meetings and lunches with the CFO where he provides you the magic number, sometimes supported with nothing more than a Post-it note with the number written on it. He frequently compliments you on your good work and promises that you'll soon be in line for a big promotion Despite the CFO's compliments and promises, you are growing increasingly uncomfortable with the journal entries you've been making. Typically, whenever an ordinary equipment purchase involves in advance payment, the purchase is completed a few weeks later. At that time, the amount of the advance is removed from an Equipment Deposit account and transferred to the appropriate cquipment account. This hasn't been the case with the CFO's special project. Instead, the Prepaid Equipment account has continued to grow. now standing at over 538 billion. There's been no discussion about how or when this balance will be reduced and no depreciation has been recorded for it Just as you begin to reflect on the effect the adjustments have hatt on your company's fixed assets operating expenses, and operating income, you receive a call from the vice president for internal audit. She need to talk with you this afternoon about a peculiar trend in the company's fixed asset turnover ratio and some uspicious journal entries that you've been making." Required: 1. Complete the following table to determine what the company's accounting cards would have looked like had you not made the journal entries as part of the CFO's special project Comment on how the decision to capitalize amounts, which were initially recorded as operating expenses, has affected the level of income from operations in each quarter 1 year (March 3 02 Year 1 (June 30) (amounts in millions of US dollars) with the Entries Without the Entries With the Entries Without the Entrie Property and Equipment, Net $38,614 $ $35.982 $ Sales Revenues 8.825 8.525 8.910 8.910 Operating Expenses 7.628 8.326 Income from Operations 1.197 384 2. Using the publicly reported number (which include the special journal entries that you recorded),compute the fixed asset turnover ratio (rounded to two decimal places) for the periodi ended Q2 Qt of year and QI of year 2. What does the trend in this ratio suggest to you? Is this consistent with the changes in operating income reported by the company Required: 1. Complete the following able to determine what the comme coming records would love looked like had you not made the journal catre part of the CFO's special project Commento how the decision to capitalice amount which were initially recorded as operating expenses affected the level of income from operation cach quarter 03 Mar 1/5eptember 30) with the Entries without the entries SISI 5 5.966 3. 7.786 1.100 04 Yar 1 December 31 1 Year 2 (March 31) With the Entre Without the Entlas with the lines without the Entries $38.00 5 5:10.155 5 471 147 NINO 3.10 33 2. Using the publicly reported in which include the special journal Curies that you recorded compte the feed it over ratio rounded to two decimal place for the periode ended 02-01 of you. I of you. What does the trend in this ratio to Sou? Is thuis consistent with the chain operation reported by the company 2. Using the publicly reported number (which include the special journal entries that you recorded). compute the fixed asset Turnover ratio rounded to two decimal places) for the periods ended Q2 Q4 of year I and QI of year 2 What does the trend in this ratio suggest to you? Is this consistent with the changes in operating income reported by the company? 3. Before your meeting with the vice president for internal audit, you think about the above computations and the variety of peculiar circumstances surrounding the special project for the CFO What in particular might have raised your suspicion about the real nature of your work? 4. Your meeting with internal audit was short and unpleasant. The vice president indicated she had discussed her findings with the CFO before meeting with you. The CFO claimed that he had noticed the peculiar trend in the fixed assets turnover ratio, but he hadn't had a chance to investigate it further. He urged internal audit to get to the bottom of things, suggesting that perhaps someone might be making unapproved journal entries Internal audit had identified you as the source of the journal entries and had been unable to find any documents that approved or substantiated the entries. She ended the meeting by advising you to find a good lawyer Given your current circumstances, detibe how you would have acted earlier had you been able to foresce where it might load you 5. In the real case on which this one is based, the internal auditors agonixed over the question of whether they had actually uncovered a fraud or whether they were jumping to the wrong conclusion The Wall Street Journal mentioned this on October 30, 2002. by stating it was clear that their findings would be devastating for the company. They worried about whether their revelations would result in layoffs. Plus, they feated that they would wamehow end up being hansed for the mess Beyond the personal consequences mentioned in this quote desen be other potential ways in which the findings of the internal auditors would likely be devastating for the publicly traded company and thote asociated within