Ethics Case: As Year End Approaches ✓ Solved

Ethics Casect89 As Its Year End Approaches It Appears That Mendez Co

The case involves Mendez Corporation, where the president suggests increasing the allowance for doubtful accounts to lower net income for the current year, aiming to present a more sustainable growth rate. The controller believes the allowance should remain at 2%, but the president's request would increase it to 4%, affecting reported net income. The primary ethical questions concern the stakeholders involved, the ethical implications of the president’s request, and whether the controller should consider the company's growth rate when estimating allowances.

Stakeholders in the Case

The key stakeholders include the stockholders, who rely on accurate financial reporting; the company's management, notably the president and the controller; and the broader corporate interests that depend on transparent and truthful financial disclosures. Additionally, employees and potential investors are indirectly affected as they interpret the company's financial health based on reported figures. The controller and president hold particular responsibility for ethical financial reporting, as their decisions directly influence the financial statements that stakeholders review.

Ethical Dilemmas Faced by the Controller

The president's request presents a significant ethical dilemma for the controller. Increasing the allowance for doubtful accounts artificially lowers net income, which can mislead stakeholders about the company's true financial performance and health. The issue revolves around whether it is ethical to manipulate financial figures to meet strategic or perceived expectations. The controller faces pressure to comply with management directives that may conflict with principles of truthful and fair reporting.

The ethical dilemma is intensified by the authority dynamic, where the president’s influence might compel the controller to act against their professional integrity. Such actions could compromise the controller’s commitment to ethical standards outlined by accounting bodies such as the American Institute of CPAs (AICPA) and the International Financial Reporting Standards (IFRS), which emphasize accuracy and transparency.

Should Growth Rate Influence the Estimation of Allowances?

Estimating the allowance for doubtful accounts should not be directly influenced solely by growth rate considerations. Instead, it should be based on historical trends, current economic conditions, and an objective assessment of receivables' collectibility. While growth rate may impact assumptions about future defaults, the primary goal of allowance estimation is to reflect the realistic risk of non-collection, not to artificially inflate or deflate net income.

However, it is crucial for the controller to recognize that a higher growth rate could lead to increased receivables, which might naturally result in higher allowances for doubtful accounts. Such an increase reflects prudent financial management and risk mitigation, not manipulative reporting. It is essential to maintain transparency and consistency in estimating allowances, ensuring they align with actual collectibility risks rather than management's strategic intents to influence financial results.

Implications of Manipulating Allowances for Earnings Management

Falsely inflating or deflating allowances for doubtful accounts can serve as an earnings management tool, which is ethically questionable and potentially violate accounting standards. Earnings management can distort financial reports, mislead stakeholders, and lead to legal repercussions. It undermines trust in financial reporting and can harm the company's reputation if uncovered.

On the other hand, conservative allowances that appropriately reflect receivables' collectibility promote transparency and uphold stakeholder trust. Ethical financial reporting requires that allowances are determined based on objective assessments rather than managerial incentives or pressures.

Legal and Ethical Standards Guiding Financial Reporting

Financial reporting is governed by standards set by bodies such as the Financial Accounting Standards Board (FASB) and IFRS. These standards emphasize that estimates like doubtful accounts should be based on reasonable, supportable assumptions. The Sarbanes-Oxley Act further reinforces the importance of ethical conduct in financial reporting, penalizing falsification and misrepresentation.

From an ethical perspective, the controller should adhere to these standards and resist pressures to manipulate figures. Ethical professionals prioritize truthful reporting that accurately reflects the company's financial position, even when such disclosures might not align with management’s strategic or personal interests.

Conclusion

In conclusion, the stakeholders in this case include stockholders, management, employees, and other interested parties relying on accurate financial disclosures. The president’s request to increase the doubtful accounts allowance, to manipulate net income, presents an ethical dilemma for the controller, who must balance management directives with ethical standards of honesty and transparency. While the company's growth rate should inform allowances for doubtful accounts, estimates must reflect realistic assessments of receivables' collectibility, not manipulated figures intended to influence perceptions of financial performance.

Maintaining ethical integrity in financial reporting safeguards stakeholder trust and ensures compliance with legal standards. The controller should adhere to objective criteria and resist pressures to distort financial data, fostering a culture of ethical responsibility.

References

• Kimmel, P., Mitchell, J., & Weygandt, J. (2021). Accounting tools for business decision making. Wiley.
• American Institute of CPAs (AICPA). (2020). Code of Professional Conduct.
• Financial Accounting Standards Board (FASB). (2022). Accounting Standards Codification.
• International Financial Reporting Standards (IFRS). (2023). IFRS Conceptual Framework.
• Sarbanes-Oxley Act of 2002. Public Law 107-204.
• Schipper, K. (1989). "Optionality and the earnings management hypothesis," The Accounting Review, 64(1), 85-109.
• Dechow, P., & Skinner, D. (2000). "Earnings management: Reconciling the views of accounting academics, practitioners, and regulators," Accounting Horizons, 14(2), 235-250.
• Healy, P., & Wahlen, J. (1999). "A review of the earnings management literature and its implications for auditors," Accounting Horizons, 13(4), 365-383.
• Graham, J., Harvey, C., & Rajgopal, S. (2005). "The economic implications of corporate financial reporting," Journal of Accounting and Economics, 40(1), 3-73.
• Lev, B. (2003). "Remarks on earnings management," Accounting Horizons, 17(4), 365-378.