Ethics and Governance: Managing the Allowance for Uncollectible Accounts Assume

Question

Ethics and Governance: Managing the Allowance for Uncollectible Accounts

Assume that you are the CEO of a publicly traded company. Your chief nancial ofcer (CFO) informs

you that your company will not be able to meet earnings per share targets for the current quarter. In

that event, your stock price will likely decline. The CFO proposes reducing the quarterly provision for

uncollectible accounts (bad debts expense) to increase your EPS to the level analysts expect. This will

result in an allowance account that is less than it should be. The CFO explains that outsiders cannot

easily detect a reduction in this allowance and that the allowance can be increased next quarter. The

benet is that your shareholders will not experience a decline in stock price.

a. Identify the parties that are likely to be affected by this proposed action.

b. How will reducing the provision for uncollectible accounts affect the income statement and the

balance sheet?

c. How will reducing the provision for uncollectible accounts in the current period affect the income

statement and the balance sheet in a future period?

d. What argument might the CFO use to convince the company’s external auditors that this action is

justied?

e. How might an analyst detect this earnings management activity?

f. How might this action affect the moral compass of your company? What repercussions might this

action have?

Explanation / Answer

Answer:a This proposed action will affect all individuals and parties that have a stake in the company. These parties include: employees, customers, suppliers, creditors, trade unions, owners, and the investors.

Answer:b The uncollectable accounts are expenses reported of the income statement; therefore, reducing this amount will result in increased net income. The uncollectible accounts are netted on the balance sheet in the receivables under current assets. If the uncollectible accounts are reduced; the result will be increased current assets. This will also result in reporting a better financial position of the company.

Answer:c.If the provision for uncollectable accounts is understated in the current period; the income statement and balance sheet will be negatively affected in the future period because the misstatement of the provision will catch up to the company’s financial statements in the future period.

Answer:d The CFO could use an argument that the company’s policies and procedures for the provision for uncollectible accounts has changed based on recent discoveries for improved methodologies for the calculation. The CFO could explain in detail the new methodology and the implementation of the new procedure.

Answer:e An analyst might detect this activity by reviewing the historical financial statements of the company against the current financial statements. The analyst would detect that the current methodology for the provision for uncollectable accounts does not follow the methodology used in previous periods.

Answer:f If the company is successful in concealing a fraudulent misstatement, the company could get caught in the trap of cooking the books at every opportunity to increase the financial position of the company. The company could lose its reputation and loyalty amongst employees, customers, suppliers, creditors, trade unions, owners, and the investors by performing a fraudulent action.

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