The CFO of Andarex, Inc. (Ticker symbol ANDX on the NASDAQ) has called the Accounting Manager into his office to discuss an issue dealing with capitalization of interest on a factory building Andarex is constructing for a new product line.

The CFO is slightly upset because the accounting department has determined that Andarex should stop capitalizing interest on the building very soon as it is near completion.

The CFO would prefer that interest continue to be capitalized for several additional months and wants to debate the treatment with the Accounting Manager.

The following slides provide an excerpt of their conversation:

CFO: I wanted to talk to you about the interest in the Worcester factory. I understand that Accounting thinks we should stop capitalizing interest on the project at the end of next month. Why is that? I was under the impression that we would continue to capitalize interest until we were ready to use the factory which is probably another six months.

Acctg. Manager: Well, that's a bit different than what the accounting rules allow, although the language might be similar. The rules allow us to capitalize interest on the project until the building itself is ready for its intended use, not when we are ready to use it. And since the project should be completed next month, we would need to stop capitalizing interest then.

CFO: Wait a minute. That seems a little nitpicking. Don't we control when the building is completed? Couldn't we just slow it down a little? I'm sure the contractor will work with us on it. This was a big contract for them.

Acctg. Manager: Well, really the building is essentially done now. We just need to clean up a few last items and go through final inspection. I think the spirit of the accounting rules...

CFO: (interrupting) That sounds pretty technical to me. And, who besides us is even going to know exactly how close to complete we are? Listen, it's really important that we continue capitalizing interest until we are ready to start using the building. It shouldn't be more than six months. I need you to get this done for us, OK? Make sure that happens, please.

Acctg. Manager: Well...

Case Study Questions

The Accounting Manager is obviously uncomfortable with what the CFO has ordered. Answer the following three questions. Make sure that each answer is complete and supported.

1. Why is the CFO so motivated to continue capitalizing interest? Explain the financial reporting implications of continuing to capitalize interest on the building past its expected completion date. Be specific.
2. Identify two outside parties that could be impacted by the CFO's decision and explain how the decision could negatively impact the parties. Examples could be investors, lenders, employees, customers, etc. You can pick those or others. Be specific on how they could be impacted.
3. Using the tools covered in the supplemental materials below (Golden Rule, Public Disclosure Test, Universalization Test, Violation of Trust Test), analyze the ethical implications of the scenario and formulate an argument that the Accounting Manager can use to persuade the CFO to change his decision. Use at least one of the tools we use in class in your argument. You may use more if you wish.