Haris is married with two children, ages 3 and 5. His wife was recently laid off from a large national bank. At this time her job prospects look bleak since her career was oriented toward the financial services industry which has been negatively impacted by the current recession.

Haris is a licensed CAwho recently accepted a position as the controller of Damai Health Care (DHC), a medium sized non-profit organization specializing in providing healthcare services to low income residents. Until recently, Haris was working for a large regional CA firm where he had a variety of audit clients including non-profit organizations. Haris was tired of the long hours and the pressure of public accounting and believed that working in the non-profit sector would be relatively free of stress and that the hours would be more predictable. When he accepted the position of controller at DHC, Haris received an increase in compensation. Since he came to work for DHC, Haris has heard that the prior controller was terminated and that it was a messy termination and that a wrongful termination lawsuit is pending.

DHC derives about eighty percent of its revenue from contracts with the city and the state. The remaining twenty percent comes from institutional and individual giving. DHC has a great reputation in the community because of the high quality of the services it provides. The current recession has materially diminished the sources of funding available to both state and local governments. Consequently, contracts between DHC and the municipalities that were once "automatic renewals" have become less certain. Contracts that are renewed often times have provisions reducing the reimbursed amounts for service units (health care services provided to clients). The nonrenewal of some contracts and the lower reimbursement amounts on new contracts is beginning to reduce working capital to dangerously low levels.

DHC has a line of credit with Rakyat Bank in the amount of RM500,000. The current economic circumstances have resulted in DHC needing to utilize the entire RM500,000 line of credit with little hope of being able to pay down the debt in the next year. DHC is using the line of credit as a source of permanent financing and Haris realizes that if the line is not renewed an immediate liquidity crisis would result. The bank requires that the line be reviewed twice yearly which entails providing them with the most recent financial statements. The six-month review is next week.

Haris reports to the CFO of DHC, Ms Chin. Haris has quickly learned that Ms Chin is a hard driving, focused executive and has aspirations to become the CEO sometime in the future. She tolerates no dissention and views discussing issues as a waste of time because of her certainty of being correct.

Ms Chin is concerned that the current financial statements will not be satisfactory to the bank. The statements reflect a fast deterioration of working capital approaching a 1:1 ratio with current liabilities needing to be paid in the next thirty days but amounts due from city and state agencies expected to be received in the next 60-120 days. The operating statement is currently showing an operating loss. Ms Chin is concerned that the statements could cause the bank to increase the interest rate on the line of credit or cause the line of credit to be cancelled. The cancellation of the line of credit would bring on such a liquidity crisis that it is doubtful that DHC could remain a going concern.

The CFO has approached Haris to discuss the current financial situation and current financial statements. She indicates to Haris that she believes that certain modifications could be made to the statements which would show DHC in a more favorable financial and operating position. She tells Haris that it is almost certain that DHC will receive a RM750,000 grant in the next 4-5 months from government. Ms Chin believes that this will eliminate the organization's liquidity problem.

Haris knows that he and the CFO must sign a cover letter accompanying the financial statements going to the bank. The letter, in essence, states that the accompanying financial statements, to the best of their knowledge and belief, present fairly DHC's financial position and the operating results in accordance with generally accepted accounting principles. Haris questions the CFO about the implication of "modifying the statements" and signing such a letter. She emphatically states that this type of "earnings management" is very common in both the profit and non-profit sectors of the economy. When survival of an entity is at stake such financial statement modification is the only thing an entity can do. "After all, where is your loyalty, to the bank or to our clients who depend on the healthcare services we provide? Any adjustments you make to the books will be reversed once we receive the RM750,000 grant and no one will know about the "modified" financial statements but you and me. Also, our audit is over six months away."

Haris knows the dire consequences of his telling the CFO he will not modify the financial statements or sign a letter accompanying the financial statements. Haris decides to postpone consideration of the long-term structural cost issues and he begins to think about how he could modify the accrual based financial statements.

His ideas are beginning to evolve:

1. Accrue revenues not yet due from the city and state. His rationalization is these items are under a contract and they will be due once DHC provides the services.

2. Exclude certain accrued expenses using the rationalization that these items do not need to be paid at this time.

3. Reclassify certain noncurrent assets as current and classify certain current liabilities as noncurrent. Haris believes that many times such classification is somewhat subjective, and he is merely using his judgment.

Haris is pleased with his ideas because these modifications will improve both the working capital picture as well as improve the operating results of DHC. Yet, he is troubled that he has been asked by the CFO to change the financial statements so that DHC looks favorable to the bank. He is equally concerned that he will need to provide his signature to the letter accompanying the statements. Haris decides to leave the office and head home to discuss these issues with his wife Mariam.

Haris and Mariam prepare the children's dinner and ready them for bed. Once Mariam and Haris have time alone, Haris describes the events of his day. He describes the conversation with Ms Chin. He outlines DHC's financial problems and the liquidity and going concern crisis that will be faced if the bank does not renew the line of credit. He tells Mariam that he must modify the statements in order for the organization to have a reasonable chance of a renewed credit line. He discusses his professional and ethical responsibilities to the profession as well as his responsibility to the general public. He asks for Mariam's perspective on the dilemma he faces.

Mariam does not hesitate to offer her opinion. "Shouldn't you consider the clients of DHC first? Many of those people would receive no health care without DHC and some of them could even die. It seems to me that temporarily adjusting the financial statements is a small price to pay to keep the services of DHC available to your clients. Face it Haris, professional ethics always sounds somewhat attractive in the classroom but what about the real world?"

After a pause, Mariam continues. "I think that you also have to consider your family. You know, if you refuse to change the financial statements, Ms Chin will probably fire you immediately and DHC will not pay severance. Where will you find a job? We have had a hard time financially since I have been out of work. How would we manage if you lost your job? Are you prepared to risk your family's well-being?"

Haris ponders the events of the day. "Ethical issues are much more difficult in reality than in the classroom-I never dreamed I would be placed in such a difficult position."

Required:

a) Discuss the dilemma faced by Haris.

(6 marks)

b) Elaborate THREE (3) possible solutions to solve Haris's problem.

(27 marks)

c) Explain the positive and negative effects of each solution provided in (b).

(8 marks)

d) Suggest recommended solution with justification.

(9 marks)