Case Study: Capitalization versus Expensing

Gloria Hernandez is the controller of a public company. She just completed a meeting with her superior, John Harrison, who is the CFO of the company. Harrison tried to convince Hernandez to go along with his proposal to combine 12 expenditures for repair and maintenance of a plant asset into one amount ($1 million). Each of the expenditures is less than $100,000, the cutoff point for capitalizing expenditures as an asset and depreciating it over the useful life. Hernandez asked for time to think about the matter. As the controller and chief accounting officer of the company, Hernandez knows its her responsibility to decide how to record the expenditures. She knows that the $1 million amount is material to earnings and the rules in accounting require expensing of each individual item, not capitalization. However, she is under a great deal of pressure to go along with capitalization to boost earnings and meet financial analysts earnings expectations and provide for a bonus to top management including herself. Her job may be at stake, and she doesnt want to disappoint her boss.

Questions Assume both Hernandez and Harrison hold the CPA and CMA designations.

1. What are the loyalty obligations of both parties in this case?

2. Assume that you were in Gloria Hernandezs position. What would motivate you to speak up and act or to stay silent? Would it make a difference if Harrison promised this was a one-time request?

3. What would you do and why?