What is the fundamental ethical isue n this situation? Discus how the proposal violated the accouning princple

Question

what is the fundamental ethical isue n this situation? Discus how the proposal violated the accouning princples. identify the specific concept or principle involved.

The board of directors of Sailormoon Corporation is meeting to discuss the past year's result before releasing financial statements to the public. the discussion includes this exchance: Makoto Aino company releasing president: "Well, this has not been a good year! Revenue is down and expenses are up. If we dont do some fancy stepping, well report a loss for the third year in a row. I can temporarily transfer some land that i own in the company's name, and that will beef up our balance sheet. Minamino, can you shave $650,000 from expenses? then we can probobly get the bank loan that we need."

Monamino Domo, company chief accountant:"Makoto, you are asking too much. GAAP are desinged to keep this sort of thing from happening" ----please answer----thank you very much

Answer 1

The fundamental ehtical issue seems the need to polish the annual results and how far would someone go for this.

I'm not sure which "accounting principle" you are refering, and I'm not sure this actually violates an accounting principle (it violates corporate law).

The most important issue seems to be the "shave $650,000 from expenses", it was not stated how this would be achieved, there are a few options, some costs can be legally converted to goodwill or fixed assets (like the renovation of a house), some costs can be scrapped (like a provision for futur repairs), or put on an off balance entity. However this can be only done in line with changed business goals.

A few examples which I believe are perfectly ethical

- A company has invested in the development of a new technology that would support the sale of a current product. It decides that it has no longer the resources to bring this new technology to the market. A partner is found and an off balance structure is setup allowing this new technology to be developed  and brought to the market. As a consequence of this the development costs are converted to an "investment" in the off balance entity.

- a decision to renew computers for 3 years rather than to renew them after 2 years will release a lot of provisions (note that this actually represents a cost saving)

There are also more questionable methods of shaving costs:

- each year companies have to make provisions for costs made but not yet received (like pensions to be paid, liabilities, warranties and guarantees given). These provisions are actually based on assumptions, by changing the assumption the provisions, hence the costs, are changed.

(the assumptions might be obsolete and then it might be justified).

However, all these changes have to be reported in the notes to the annual accounts, good investors will notice this.

Polishing balances and P/L-statements to obtain bankloans is only allowed if they polished statements still give a true and accurate view of the company.

US GAAP is not desinged to keep such things from happening, only to put every company equal and to make sure that comparable companies publish comparable accounts. (and yes the need to explain in the notes makes it very hard to hide such things).

I'm more concerned with "I can temporarily transfer some land that i own in the company's name". Corporate law gives the officers a fiduciary duty which prevents the company from acquiring assets solely for the pleasure of the directors. (although there might be historic reasons for it). However selling land (=replacing it with cold cash on the bank) is a perfectly good way of doing business.