After two years as an auditor for a large national accounting firm, Manuel Gonzales wants to jump into industry. Healer Tech Inc. (HT), a small start-up company that develops and manufactures technology-embedded medical devices, just won a second round of venture capital money and is looking for an assistant controller. Even a non-technical person like Manuel can see the demand for their product and, if the product is a hit in the market place, HT could become a major corporation. Besides the growth potential, what really attracts Manuel is something much more personal. The major product of HT is an examination equipment that quickly gathers the patient’s vitals to detect the cause of strokes. Because strokes could be caused by various reasons, the timely diagnosis of the cause is critical for the emergency response and treatment. With technologies like big data processing and machine learning readily available, the fast diagnosis of the cause has now become feasible. Manuel knows too well its importance because his own grandmother passed away precisely because of the delay in finding the cause of her stroke. A few minutes’ difference is a matter of life and death. Manuel feels that by joining this company, he is contributing to preventing the tragedy of his grandmother’s from happening to other people. At the job interview, Manuel learnt that the CEO had a personal story much like his. Ms. Karst’s own father also died because of a stroke. Manuel felt the instant bond and the job offer he later got told him that Ms. Karst probably felt the same way.

Growing Excitement

Time passed and Manuel became a solid contributor. Though the controller had all the direct contact with management, as assistant controller, Manuel helped prepare the monthly financials and slides. He understood them and could explain them, too. HT grew to 150 employees. Each month, everyone felt the excitement grow as orders and revenue increased. About one year passed and the venture capital owners granted a third round of financing. The pressure was intense to increase orders, but Manuel knew that the venture capital owners concentrated most of all on shipments or revenue to indicate the health of the start-up. Shipments meant that HT could actually manufacture a product, delight customers, create a brand, establish a market for the products, make money and, ultimately, go public. This would make the venture capital owners and the employees successful. Then it happened. In an effort to keep expenses low, the accounting department always had insufficient people. The accounts payable and accounts receivable were not clean and reconciled. The year-end audit results reflected these weaknesses. When the accounting department reported the situation to the new management team, the controller was fired and Manuel was named the interim controller until a permanent replacement could be found. Unfortunately, the month-end close was coming up and it was a critical month. The venture capital partners expected growth in revenue this month. The management staff was highly experienced so they did not encourage unethical behavior, but Manuel felt very uncomfortable being the sole judge of whether the financial statements were fairly stated. Moreover, as the lame duck interim controller, Manuel felt out of his league-and believed that everyone knew it.

The Meeting

As the month-end approached and a visit from the venture capital owners loomed, Manuel anxiously watched shipment levels. The manufacturing facility was located a mile away, and after long days at the office Manuel did not normally go to the plant at month-end to review for proper shipment cutoffs. Manuel had not worried about cutoffs very much except for the annual wall-to-wall physical inventories. Three days before the month end, Ms. Karst called the management team into a meeting. As the interim controller, Manuel was also invited. At the meeting, Ms. Karst, Mr. Rochers (the COO) and Ms. Tyson (the VP of marketing) shared their vision of increasing investments in R&D to develop a cheaper and easier-to-ship version of HT’s stroke detection equipment aimed for developing countries. Ms. Karst acknowledged that the plan could be a hard sell to the venture capitalists as HT is still in its early stage and expanding to overseas markets was a risky strategy. “However, developing countries are a large market and the people there need our equipment even more than they do here in the States. With the limited medical resources in those countries, having our equipment there can save millions of lives.” Ms. Karst said, “What we need to do is to convince the venture capitalists that our operations are viable and growing, and we can totally handle the expansion. Plus, our marketing team has some good news that will help seal the deal.” She then looked at Ms. Tyson. “That’s right,” said Ms. Tyson, “We are finalizing a large order with one of our customers. In fact it is the largest order we’ve ever received! The bulk part of the contract has already been worked out. Now there are just some finishing touches, and if all goes according to schedule, the order will come in by the day after tomorrow the latest.” Manuel could feel the excitement in the room. Then Ms. Karst spoke again. “I went through some numbers and it looks like with this order being counted as our revenue for the current month, we will exceed the venture capitalists’ expectations as it beats even the best case scenario we projected for them. Is that right, Manuel?” Manuel felt both excited and nervous. It is the first time he was asked to speak at a meeting this high level. Blushing slightly, he replied, “Yeah. It’ll help us beat their expectations big—as long as we can ship it off before the month end so that it meets our cut off for booking revenue.” After the conference, Ms. Karst stopped Manuel and wanted a quick word. “I don’t want to tell you how to do your job,” she began, “but I talked with Mr. Rochers and he confirmed that we’ve got enough finished goods ready to be shipped for the order. The actual packaging and shipping might take some time, but as long as we have the order attached to our products then what difference does it make whether they’re shipped or not? I really want to put our best foot forward when the VCs come. For our products to be able to reach millions of people in the countries where they need them the most—I think you want that as much as I do. It’s about saving lives. You of all people should understand.”

The Problem

About 4:00 pm on the last day of the month, the order came in. Manuel didn't see how manufacturing could convert an order to a shipment so quickly and he felt that the accounting rules were being stretched. Manuel went to his office, closed the door and asked himself several questions. When does a shipment physically occur? When it rolls off the production line? When the product is placed in a box and the box taped shut? When the address label is put on the box? When the box is placed on the loading dock? When the box is placed in the freight truck? When the truck leaves the premises? If the freight company's last pickup is at noon; should you count boxes that are labeled and placed on the shipping dock that afternoon and ready for pickup by the freight company the following workday? What if the freight truck only came twice a week and month-end was two days after the last freight pickup? His CPA training did not touch on these questions.

The Options

Manuel tried to call two audit managers at the CPA firm where he once worked. One contact said that the shipments had to be on a third-party truck. The other said that the rules for month-end cutoffs are not as strict as those for year-ends, and the product didn't need to be in a box but could be counted if it was in the finished goods/shipping area and had an order attached to it at midnight. In other words, there was no clear answer and it was up to Manuel's judgment. Then Manuel recalled Ms. Karst’s words. “It’s about saving lives. You of all people should understand.” What should he do?

Requirements

Analyze the decision that Manuel is facing in the case using the ethical decision framework and theories that we discussed in class. Specifically, write an essay that addresses the following questions:

1. What is the core principle of revenue recognition according to GAAP (specifically, ASC 606—revenue from contracts with customers)? What are the five steps of implementation under the core principle? Apply the core principle and the steps under the specific context described in this case.

2. What decision is Manuel trying to make? What are the options?

3. What are the consequences of each option? Who will be affected? In what ways will they be affected?

4. According to the four theories of ethical decision making (i.e. Ethical Egotism, Utilitarianism, Deontology and Virtue Theory), what option should Manuel choose under each theory?

5. Make your recommendation to Manuel on the action(s) that he should take.