Katie Schmaltz, CPA, CIA, has just been promoted to assistant controller of Mottins Corporation, a publically traded company that manufactures component parts for consumer electronics. For the past four years, she worked for Mottins as their internal auditor. She enjoyed her work as internal auditor, but she is excited about becoming the company's assistant controller. Katie is very proud of being an accounting professional and believes that professional ethics are of paramount importance. She considers Cynthia Cooper, the internal audit director who together with two colleagues discovered and the reported the WorldCom fraud, a role model. The company recently and unexpectedly lost its controller to early retirement. The new controller, Jim Kariton, will be joining the company in a few days. Meanwhile, Katie familiarizes herself with the financial reporting process, the general ledger, and the most recent financial statements.

Journal of the International Academy for Case Studies, Volume 15, Number 1, 2009

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Mottins Corporation has been growing and prospering during the past five years. As part of its growth and expansion project, the company recently purchased the patent for a new innovative parts manufacturing process that the company hopes will increase its sales by 100 percent over the next five years.

Mottins Corporation sponsors a defined benefit pension plan, as well as a postretirement health care plan. Virtually all of the company's employees are covered by these plans. Both plans are underfunded; the pension plan is slightly underfunded, while the other postretirement benefit plan is significantly underfunded. Consistent with the requirements of SFAS 87 and SFAS 106, no liability had to be accrued on the company's 2005 balance sheet for its retirement benefit plans.

Katie reviews the note disclosures for the defined benefit pension and retiree health care plans and notices that for the fiscal year ended December 31, 2006, the company properly adopted SFAS 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans," which amends both SFAS 87 and SFAS 106. The following are selected disclosures from the Mottins Corporation's 2006 financial statements.

SELECTED INFORMATION FROM THE 2006 FINANCIAL STATEMENT NOTES Financial Statement Note No. 9: Retirement Plans

Effective fiscal year 2006, the Company properly adopted Statement of Financial Accounting Standards No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans." Consistent with the requirements of SFAS 158, the funding statuses of the Company's defined benefit retirement plans must be disclosed and are as follows:

$ 6,855 6,790 $ (65)

$ 39

Journal of the International Academy for Case Studies, Volume 15, Number 1, 2009

Funding Status of Defined Benefit Pension Plan

December 31, 2006 (in thousands)

Projected benefit obligation

Plan assets at fair market value

Funding Status

Items not yet recognized as components of net periodic pension cost (expense)

Prior service cost

Unrecognized net loss

26

Funding Status of Retiree Health Care Plan

December 31, 2006 (in thousands)

Accumulated benefit obligation

Plan assets at fair market value

Funding Status

Items not yet recognized as components of net periodic health care cost (expense)

Transition Obligation

Prior service cost

Unrecognized net loss

18

$ 1,010 852 $ (158)

$ 40 100

The Company utilized the following rate assumption in accounting for its defined benefit retirement plans:

5.5 9 3 2005

(in percent) 5.5 9

While reviewing the financial statement disclosures, Katie notices that Mottins recognized $223,000 in long-term pension and other postretirement benefit liabilities. Katie, who had read in the financial press that some companies that sponsored underfunded employee retirement plans were quite adversely affected by the provisions of the new standards, is pleased to learn of this relatively small impact of SFAS 158 on her company's financial statements.

Upon further review of the financial statement notes regarding the pension and postretirement health care plans, she notices that the company increased its discount rate assumptions from 5.5 percent to 6 percent for the year 2006. She recalculates the projected pension and accumulated postretirement benefit obligations utilizing the 2005 discount rate assumptions and realizes that the total effect of the 0.5 percent increase in the discount rate was a reduction of $846,000 in total liabilities. She calls the actuary who provides actuarial assumptions and estimates

Journal of the International Academy for Case Studies, Volume 15, Number 1, 2009

Rate Assumptions - Pension Plan

2006 (in percent)

2005 (in percent)

Discount rate

6

Return on plan assets

9

Salary trend rate

3

Rate Assumptions - Retiree Health Care Plan

2006 (in percent)

Discount rate

6

Return on plan assets

9

Health care trend rate

7

7

for the company's plans and learns that the change was within reasonable limits and had been specifically requested by the former controller.

Two weeks later, Jim Kariton, the new controller discusses a number of forthcoming financial reporting issues with Katie. Katie is pleasantly impressed by the new controller's qualifications, personality, and interpersonal skills. She is looking forward to a collegial and rewarding professional relationship with her new superior.

At the end of their conversation, Jim instructs Katie to contact the company's actuary and request his support for increasing the discount rate by 0.25 percent in 2007 and the long-term expected rate of return on plan assets by 0.25 percent for both the pension and retiree health care plans. Katie states that she noticed that the discount rate had already been increased by 0.5 percent for 2006. Jim indicates that a further increase is warranted by overall increases in interest rates, and that the long-term expected rate of return on plan assets should be increased to 9.25 percent due to an enhanced outlook for the plans' investments. Katie can't help wondering about the motivation for this newest increase.

A week later, while visiting Chief Financial Officer (CFO) Mike Johans' office to drop off a report, she overhears him speaking with the pension fund manager, asking for a change in the investment mix to increase the percentage of higher-yield, lower-rated securities in the plan assets. During the phone conversation, he impresses on the fund manager that the equity markets are expected to flourish. Katie has heard that the fund manager is a good friend of the CFO and that they play golf together on a weekly basis.

Katie talks to her friend in Human Resources and learns that the CFO has apprised the Director of Human Resources about a potential change in the retirement plan to a 401(k) plan for new employees and the elimination of the retirement health care plan. Katie, who also is covered under the current plans, is concerned for her and her colleagues' welfare.

Katie is unaware that meanwhile, the Chief Executive Officer (CEO), John Ballon, has been meeting with individual board members for lunch and other outside activities, utilizing the opportunity to encourage them to vote for a curtailment of employee retirement benefit plans. John Ballon knows that the company will need to decrease its expenses to continue meeting or beating its earnings trends and targets. John's and other executives' bonuses are directly contingent on meeting earnings forecasts. In addition, John holds a large number of stock options, currently valued at 1.4 million dollars. He plans to meet earnings forecasts for each year until his planned retirement in three years.

A few weeks later, one of Katie's colleagues casually mentions that her boss, CEO John Ballon has been meeting with several board members, some of whom are also on the company's audit committee. She also mentions that she overheard a reference to employee retirement plans. After considering this new information, Katie begins to suspect that the CEO may be trying to influence board members' votes regarding the retirement plans.

Journal of the International Academy for Case Studies, Volume 15, Number 1, 2009

Later that day, Jim Kariton asks Katie to review the financial statement notes and disclosures relating to the company's property, plant, equipment, and intangible assets. Katie notices that the notes describe the useful life of the patent as 17 years. She asks Jim Kariton whether this represents an appropriate estimate given the rapid change in technology. He immediately responds with the statement that "This is not a concern; we are amortizing the cost over the legal protection of the patent remaining at time of purchase." Katie doubts that this technology really will be useful for 17 years and offers to ask the engineering department to provide an updated estimate of the usefulness of the patent. Jim Kariton states that this not necessary and that any change in the useful life likely would be immaterial.

Katie decides to again mention her concerns regarding the planned increases in the discount rate and rate of return assumptions for the retirement benefit plans; the controller states that the increases are justified and that the CFO recommended them. Katie asks him whether the company is planning any future changes in the retirement plans. The controller indicates that he knows of no such plans and again asks her not to concern herself about these issues. He also hints that if financial results are favorable for the company he will recommend that she receive a bonus for all her hard work.

Katie decides to call the company's former controller at home to inform him of her promotion to assistant controller and perhaps gain some insights into the prior year discount rate change. After a few minutes of pleasant conversation, she asks him about the increase in the discount rate for 2006. The former controller tells her that "top management requested the change." He also says that he is enjoying retirement and his part-time teaching position at the State University. At the end of the conversation he advises her to be diligent about her new position and to always remember what the "CPA" and "CIA" certifications stand for. Katie feels that she has been subtlety warned. Katie is uncertain about what she should do.

2. Why would increasing the discount rate assumptions affect the pension plan and health care plan liabilities recognized on the balance sheet? How would the planned increase in the rate of return on plan assets likely affect Mottins' financial statements? Do you believe that the changes in the rates requested by the controller and CFO are reasonable?

3. If Mottins Corporation had not increased its discount rate during 2006, how would its financial statements have differed? How did the change affect the company's stakeholders?

4. Review the authoritative literature regarding accounting changes and relate it to the discount rate and rate of return changes for pensions and other postretirement benefits. Under what circumstances are changes in estimates justifiable? Does the situation in this case meet the criteria?

5. Review the authoritative guidance regarding the amortization of intangible assets. What are the criteria for selecting the useful life of an intangible asset, such as a patent? Do you agree with Mottins' accounting treatment for its patent?

6. Evaluate the behavior of the individuals involved in this case from an ethical perspective. What are their ethical and professional responsibilities? What may be the motivation for their behavior?

7. Katie apparently feels uncomfortable with some of the accounting estimates and changes in estimates. What options does she have to address these issues and potentially solve her dilemma? What are Katie's professional responsibilities in this case?

8. What would you do if you were in Katie's position?