Eduardo Garcia has just been hired as the controller for Toro Enterprises. To become familiar with the company, he is reviewing the nancial statements for 2013. The previous controller completed the year-end nancial statements beforehe leftand mailedthem to the holderof the long-term bondsasrequired bythedebtcovenants.Eduardoisdismayedto ndseveralerrorsinthe nancial statements. The previous controller, George Wilson, prepared several adjusting entries on January 10, 2014. The explanations for these entries were "to avoid default on the debt covenant". George had recognized revenue on a large order received on December 28 but shipped on January 3, and had reduced depreciation expense by $2,300,000. Both of these items were designed to increase earnings per share to the required amount.

a. What is the accounting and ethical problem for Eduardo? What pressure does Eduardo face?

b. Based on your knowledge of accounting standards, what is the appropriate accounting treatment for these items?

c. Identify the stakeholders affected by the errors in the nancial statements presented to the bondholders. Who benets? Who is harmed? Is there a conict of interest between the stakeholders?

d. What alternatives are available to Eduardo? Is it worse to admit to the bondholders that your predecessor made a mistake than to hide it?

e. What would you do? Why?