Case Question: Technical, Inc. (25 marks)

Sarah Slean is an internal accountant at Technical Inc., a publicly-owned company headquartered in Mississauga, Ontario. Sarah reports to Christine Hodgins, the controller of the company. Hodgins reports to the CFO, Laleh Farshadfar. Farshadfar reports to George Lee, the CEO. Furniture has a three-person independent audit committee that deals with financial oversight issues including being a direct access group for matters of concern for the chief internal auditor, Sam Vines.

On January 15, 2022, Slean is approached by Hodgins and told to record an accrual for unpaid bonuses and severance payments of $50 million to be included in the December 31, 2021, financial statements. Slean asked Hodgins to explain the reason for what appeared to be an unusually high amount and was told the company planned to shut down a division in 2022 and the severance payments would be significant. This was the first Slean heard about a shutdown of any division and found it strange because the companys operating income in all divisions had set record levels in fiscal year 2021. Moreover, the bonus and severance amounts are five times the annual payroll of the division.

The numbers below show the operating income levels and accruals for 2019 through 2021.

12/31/19 12/31/20 12/31/21

Operating Income $ 100 million $120 million $200 million

Accrued bonus & severance $ 10 million $ 12 million ???

Slean did not commit to recording the accruals because she wanted more time to think about the situation. Fortunately, Hodgins was called away on an urgent matter, bringing the meeting to an abrupt halt.

Slean decided to speak to Gloria Olson, a fellow internal accountant who graduated with Slean from university. Olson also found the amount of accruals unusually high. Slean asked Olson what the projected operating income was for December 31, 2022 based on her recent calculations. Olson told him it was determined to be $160 million. They briefly talked about the projected decline in operating income after five straight years of increases. Slean wondered whether the reason could be attributable to the shutdown of the division mentioned by Hodgins.

Assume Slean, Hodgins, Farshadfar, Vines and Olson are all CPAs.

Place yourself in Sarah Sleans shoes and answer the following questions:

a. How do you characterize this case in terms of earnings management (Is it real or accounting based explain this? What might you call this type of accrual explain this? What is the effect on current and future earnings? Etc.) (10 marks)

b. Assuming there is going to be a shutdown of a division, what might be an appropriate accrual amount? (2 marks)

c. Assume that the division is going to be shut down. Assume you meet with Hodgins and he instructs you in no uncertain terms to record the accrual. What would you do and why? Apply the modified 5-question approach here as an ethical decision-making approach in supporting your decision. (13 marks)