John Gump graduated from Cal State Fullerton five years ago. He is a CPA. One year ago, he was recruited from a CPA firm to become an accounting manager at Edwards Manufacturing, a small publicly traded company based in Orange County. He reports to CFO, Mike Young. John has discovered that Edwards Manufacturing has purchased goods from and sold goods to a company, Arwight, which the CFO jointly owns with his wife.

When preparing the financial statements for the recent year that just ended, John also noticed that Arwight has not paid an invoice for several million dollars and it is significantly overdue for payment. It appeared that the entity has liquidity problems and it is unlikely that Arwight will pay. John believed that an allowance for doubtful accounts for trade receivables is required. He set up a meeting with the CFO. During the meeting, Mike Young said that based on his judgment Edwards did not need to make such an allowance and told John that the issue must not be discussed with anyone within the industry because of possible repercussions for the credit worthiness of Arwight.

Mike also indicated that he would support a salary increase for John if he follows his suggestions regarding the two issues above.

Required:

1. The preparation and audit of financial statements have always required the exercise of professional judgment. Please provide three examples where judgement is necessary in financial reporting. (15 points, 5 points for each example)

2. Based on your knowledge of the U.S. GAAP, please discuss the accounting issues/debates between John and CFO in the above situations. Please prepare journal entries and/or disclosure statements if necessary. (10 points, 5 points for each suggestion)

3. Please list and describe two questions that you expect a skeptical auditor would ask with regard to the issues in this case (10 points, 5 points for each suggestion)

4. Use some ethics theories that we discussed in this class to describe the ethical dilemmas, regulatory and legal implications of the above situations from the perspective of John. (10 points, 5 points for each suggestion)

5. Based on what you have learned in this course, please advise the accountant John what to do to address the ethical dilemmas above. (15 points, 5 points for each suggestion)