problem 1.11

Emily Henson, controller of an oil exploration division has been approached by Tim Wilson, the divisional manager. Tim told Emily that the projected quarterly profits were unacceptable and that expenses need to be reduced He suggested that a clean and easy way to reduce expenses is to assign the exploration and drilling costs of four dry holes to those of two successful holes. By doing so, the costs could be capitalized and not expensed, reducing the costs that need to be recognized for the quarter. He further argued that the treatment is reasonable exploration and drilling all occurred in the same field thus, the unsuccessful efforts really were the costs of identifying the successful holes. "Besides, " he argued, "even if the treatment is wrong, it can be corrected in the annual financial statements. Next quarter's revenues will be more and can absorb any reversal without causing any severe damage to that quarter's profits. It's this quarter's profits that need some help." Emily was uncomfortable with the request because generally accepted accounting principles do not sanction the type of measures proposed by Tim. Required: Using the code of ethics for management accountants, recommend the approach that Emily should take. Suppose Tim insists that his suggested accounting treatment be implemented. What should do? Silverado, Inc., is a closely held brokerage firm that has been successful over the past five years, consistently providing most members of the top management group with 50 percent bonuses. In addition, both the chief financial officer and the chief executive officer have received 100 percent bonuses. Silverado expects this trend to continue. Recently the top management group of Silverado, which holds 40 percent of the outstanding shares of common stock has learned that a major corporation is interested in acquiring Silverado. Silverado's management is concerned that this corporation may make an attractive offer the other shareholders and that management would be unable to prevent the takeover. If the acquisition occurs, this executive group is uncertain about continued employment in the new corporate structure. As a consequence, the management group is considering changes to several accounting policies and practices that, although not in accordance with generally accepted accounting principles, would make the company a less attractive acquisition. Management has been Larry Stewart, Silverado's controller, to implement some of these changes. Stewart has also been informed that Silverado's management does not intend to disclose these changes at once anyone outside the immediate top management group. Using the code of ethics for management accountants, evaluate the changes that Silverado's management is considering, and discuss the specific steps that Larry Stewart should take to resolve the situation. (CMA adapted)