Hard Bodies Co Is A Fitness Chain That Has Just Completed It

Hard Bodies Co Is A Fitness Chain That Has Just Completed Its Second

Hard Bodies Co. is a fitness chain that has just completed its second year of operations. At the beginning of its first fiscal year, the company purchased fitness equipment at a cost of $600,000 and estimated that the equipment would have a useful life of five years and no residual value. The company uses the straight-line depreciation method. The company reported net income for the first two years of operations as follows: YearNet Income (Loss) 1$50,0002(2,000) Mike Gambit, the company's chief financial officer (CFO), has recently run financial models to predict future net income, and he expects net losses to continue at $(2,000) per year for the next three years. James Steed, the president of Hard Bodies, is concerned about these predictions, as he is under pressure from the company's owner to return the company to Year 1 net income levels. If the company does not meet these goals, both he and Mike will likely be fired. Mike suggests that the company change the estimated useful life of the fitness equipment to 10 years and increase the equipment's estimated residual value to $50,000. This will reduce depreciation expense and increase net income. Evaluate the decision to change the equipment's estimated useful life and estimated residual value to improve earnings. How does this change impact the usefulness of the company's net income for external decision makers? If Mike and James make the change, are they acting in an ethical manner? Explain. Tonya Latirno is a staff accountant for Cannally and Kennedy, a local CPA firm. For the past 10 years, the firm has given employees a year-end bonus equal to two weeks' salary. On November 15, the firm's management team announced that there would be no annual bonus this year. Because of the firm's long history of giving a year-end bonus, Tonya and her co-workers had come to expect that bonus and felt that Cannally and Kennedy had breached an implicit agreement by discontinuing it. As a result, Tonya decided that she would make up for the lost bonus by working an extra six hours of overtime per week for the rest of the year. Cannally and Kennedy's policy is to pay overtime at 150% of straight time. Tonya's supervisor was surprised to see overtime being reported, because there is generally very little additional or unusual client service demands at the end of the calendar year. However, the overtime was not questioned, because employees are on the “honor system” in reporting their work hours. Is Cannally and Kennedy acting in an ethical manner by eliminating the bonus? Is Tonya behaving ethically by making up the bonus with unnecessary overtime? Why? CEG Capital Inc. is a large holding company that uses long-term debt extensively to fund its operations. At December 31, the company reported total assets of $100 million, total debt of $55 million, and total equity of $45 million. In January, the company issued $11 billion in long-term bonds to investors at par value. This was the largest debt issuance in the company's history, and it significantly increased the company's ratio of total debt to total equity. Five days after the debt issuance, CEG filed legal documents to prepare for an additional $50 billion long-term bond issue. As a result of this filing, the price of the $11 billion in bonds that the company issued earlier in the week dropped to 94 because of the increased risk associated with the company's debt. The investors in the original $11 billion bond issuance were not informed of the company's plans to issue additional debt so quickly after the initial bond issue. Did CEG Capital act unethically by not disclosing to initial bond investors its immediate plans to issue an additional $50 billion debt offering?

Paper For Above instruction

Ethical and Financial Implications of Accounting Decisions and Disclosure Practices

Corporate financial reporting and decision-making are fundamentally governed by principles of transparency, honesty, and ethical conduct. The scenarios presented in this case study highlight critical issues surrounding accounting policies, managerial incentives, and the ethical responsibilities of companies towards their stakeholders. This paper will analyze the ethical considerations of changing depreciation estimates, working overtime to compensate for lost bonuses, and the disclosure of future debt plans, emphasizing their effects on external decision-makers and the integrity of financial reporting.

Changing Depreciation Estimates: Ethical Considerations and Impact on Financial Reporting

In the case of Hard Bodies Co., CFO Mike Gambit proposes changing the estimated useful life of fitness equipment from five to ten years and increasing the residual value to $50,000 to inflate net income figures. Under generally accepted accounting principles (GAAP), depreciation estimates are based on management’s judgment but must reflect a realistic assessment of asset utility and residual value (FASB, 2020). Altering these estimates solely to improve reported earnings raises significant ethical concerns, as it may distort the true financial position and operational performance of the company.

From an ethical standpoint, such a decision might be considered manipulative if it is aimed primarily at meeting income targets or appeasing external pressures, rather than providing a fair representation of asset consumption. External users—investors, creditors, and regulators—depend on truthful financial information to make informed decisions. Manipulating depreciation estimates compromises this reliability, potentially leading to misguided investment choices or credit assessments (Healy & Palepu, 2003). Although changing estimates is permissible within GAAP, it must be justified by genuine changes in circumstances rather than strategic motives.

Uses of financial statement analysis demonstrate that artificially extending asset lives to mask depreciation expense can temporarily boost net income but ultimately mislead stakeholders about future capital expenditure needs and operational sustainability. External decision makers value consistency and transparency; altering depreciation estimates without clear, justifiable reasons erodes the credibility of financial reports, compromising the company's reputation and the trust of its stakeholders (Graham et al., 2017).

Managerial Incentives and Ethical Concerns in Financial Reporting

In this context, the decision to modify depreciation estimates to achieve specific income targets illustrates a potential ethical breach that aligns with "earnings management" practices. While management is permitted to make estimates within GAAP, strategic manipulation for short-term gains undermines the fundamental principles of fair disclosure and integrity (Laux & Leuz, 2009). Ethically, managers have an obligation to represent the financial reality faithfully, even if it conflicts with performance expectations imposed externally.

Elimination of Bonuses and Unnecessary Overtime: Ethical Boundary

Turning to the scenario involving Cannally and Kennedy, the firm’s decision to eliminate the year-end bonus—a longstanding implicit benefit—raises questions about ethical conduct in corporate management. The firm's breach of expectations may be viewed as breaking an implicit contract, which damages employee trust and morale (Seijts & Latham, 2005). Even though the bonus was uncontracted, longstanding practices create normative expectations that employees rely upon, forming an ethical obligation for the company to honor such practices or communicate transparently.

In response, Tonya Latirno’s decision to work extra hours to compensate for the lost bonus complicates ethical analysis. She is acting out of a sense of fairness and loyalty, attempting to uphold her own perception of fairness and compensate for what she views as an unfair treatment (Trevino & Nelson, 2017). However, her action of working overtime primarily for financial gain at the company's expense raises concerns over whether she is engaging in an ethic of honesty or exploiting systemic laxness in overtime reporting. Her behavior may be considered ethically justifiable as an attempt to correct perceived unfairness but potentially problematic if it leads to misreporting or violates labor agreements.

Ethical Evaluation of Disclosure Practices in Debt Issuance

Finally, CEG Capital's decision to withhold immediate plans to raise additional debt from the initial bond investors presents a serious ethical issue. Transparency and full disclosure are fundamental principles underpinning financial markets’ integrity (Healy & Palepu, 2003). By not informing investors about the planned $50 billion bond offering, the company potentially engaged in scenarios akin to information asymmetry, where some investors possess material information not available to others. This could mislead initial investors into undervaluing the risk associated with their investment, especially given the decline in bond prices following the announcement of the second debt issuance (Liu & Ryan, 2012).

Legal and ethical standards necessitate that companies disclose material information that could influence investor decisions. Failure to do so risks breaching fiduciary duties and could be construed as deceptive conduct, damaging the company’s credibility and exposing it to legal liabilities (Larcker et al., 2014). The lack of transparency in this scenario contravenes principles of good corporate governance and ethical conduct in financial reporting, emphasizing the importance of full disclosure to maintain market fairness and stakeholder trust.

Conclusion

In sum, strategic adjustments to accounting estimates and disclosure practices must be guided by ethical principles that prioritize transparency, honesty, and integrity. While managerial discretion allows for certain judgments within GAAP, using such discretion to manipulate earnings or deceive investors undermines the foundational trust essential for functioning financial markets. Companies should aim to provide truthful, consistent, and comprehensive information, fostering sustainable relationships with stakeholders and upholding the integrity of financial reporting.

References

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