Solway, Inc. Ben Davis is an internal accountant at Solway, Inc., a pub- licly o
ID: 2512446 • Letter: S
Question
Solway, Inc. Ben Davis is an internal accountant at Solway, Inc., a pub- licly owned company headquartered in Fresno, California. Ben reports to Chris Hodgins, the controller of the company; Hodgins reports to the CFO, Harry Benson; and Benson reports to George Lee, the CEO. Solway has a three-person independent audit committee that deals with financial over- sight issues, including being a direct access group for matters of concern for the chief internal auditor, Sam Vines. acc als ask for Ol Th inc On January 15, 2014, Davis is approached by Hodgins and de told to record an accrual for unpaid bonuses and severance th payments of $50 million to be included in the December 31, 2013, financial statements. Davis asked Hodgins to explain the reason for what appeared to be an unusually high amount of money and was told the company planned to shut down a A division in 2014 and the severance payments would be sig- al nificant. This was the first Davis heard about a shutdown of (C any division, and he found it strange because the company's operating income in all divisions had set record levels in fis- cal year 2013. Moreover, the bonus and severance amounts are five times the annual payroll of the division. The numbers below show the operating income levels and accruals for 2011 through 2013 12/31/11 12/31/12 12/31/13 Operating Income Accrued bonus and severance $100 million $120 million $200 million $10 million $12 million ??? Davis did not commit to recording the accrials because he wanted more time to think about the situation. Fortunately Hodgins was called away on an urgent matter, bringing th 3Explanation / Answer
Answer to question 1
Earnings management is a mechanism wherein companies tend to create provisions which are not required. These provisions help normalise profit presented by the management , i.e. these reduce profits when the company is doing very well and when a company is not doing well, such provisions are released back, adding to the profits, and therefore, allowing the company to present stable profits to its shareholders.
In this context, information provided states that all divisions had record profits during the year. Therefore, the case of creating a provision which may not be required seems a clear attempt at earnings management, with the intent to reduce the provision as and when the company has a bad year or so and faces a low profit or even a loss situation.
Answer to Question 2:
Answer to question 3
In case Hodgins does not budge on the creation of provision and insists on creating one, following are the options available:
At the very minimum, I would try and get written approval of the boss. In case the boss is adamant and does not with to provide the documents or approval, I would escalate this issue to the Board of Directors or through a whistleblower helpline.
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