Ethics and Governance: Managing the Allowance for Uncollectible Accounts

Assume that you are the CEO of a publicly traded company. Your chief nancial ofcer (CFO) informs

you that your company will not be able to meet earnings per share targets for the current quarter. In

that event, your stock price will likely decline. The CFO proposes reducing the quarterly provision for

uncollectible accounts (bad debts expense) to increase your EPS to the level analysts expect. This will

result in an allowance account that is less than it should be. The CFO explains that outsiders cannot

easily detect a reduction in this allowance and that the allowance can be increased next quarter. The

benet is that your shareholders will not experience a decline in stock price.

a. Identify the parties that are likely to be affected by this proposed action.

b. How will reducing the provision for uncollectible accounts affect the income statement and the

balance sheet?

c. How will reducing the provision for uncollectible accounts in the current period affect the income

statement and the balance sheet in a future period?

d. What argument might the CFO use to convince the companys external auditors that this action is

justied?

e. How might an analyst detect this earnings management activity?

f. How might this action affect the moral compass of your company? What repercussions might this

action have?