Lecture 4 csr
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Donna discovers that the CFO of her new company, ABC.com, improperly recorded bartered revenue transactions which inflated reported sales figures. As the company is scheduled to announce earnings and pursue a stock offering, Donna must decide whether to resign without disclosure or confront management about the accounting issues, risking damage to her reputation. If I were in Donna's position, I would confront management about the improper revenue recognition and insist they issue a disclosure to investors correcting the financial statements. While it may damage my reputation in the short-term, failing to disclose the truth would be unethical and put many stakeholders at risk of financial harm from misleading information. Maint
Lecture 4 csr
- 1. Case Analysis "This can't be happening again. Not just three weeks into my new job!" Donna Butler's mind was racing as she laid down the sales contract that she was reading. How did she get herself into this precarious position--again? A couple of weeks ago, Donna acquired a job as the CFO of a young public company called Seagent, one of the new breed of businesses that offered their services over the Internet. Unfortunately, Donna had realized fairly early on that there were some problems with revenue recognition at her new company. She immediately went to the CEO to tell him about her discovery. During their meeting, Donna had matter-of-factly stated that some of the revenue figures would have to be re-evaluated and most likely reduced before the company would be ready to go public. Within a few days of her meeting, the CEO was telling her that she "just wasn't working out." Even though Donna knew that her opinion of the revenue recognition policies was not arguable, she had never before been punished for doing the right thing. After all, she had graduated as the top of her accounting class and this was petty basic accounting theory. Maybe the revenue recognition issue wasn't really the problem and she really wasn't working out? Either way, Donna was devastated and just wanted to put this experience behind her. Then came the offer from ABC.com Company. ABC.com Company produced and published Web-based distance learning courses and sold them to businesses and universities. The company had gone public a year ago last November and was about to report its first full year of earnings as a public company. In evaluating the position, Donna had meticulously read through all of ABC.com's SEC filings. It was a comfort to her that the company was already public and under the watch of the SEC. She was also impressed with the apparent level of candor in the company's financial statement disclosures and management's discussion and analysis. It was no doubt a risky move to go to another start-up, particular one with an unproven business plan and sales just under $1 million the year it went public. But this year, sales would reach $14 million and the industry experts estimated that the total distance learning market was about $20 billion. With a market size that large, there was plenty of room for growth. That potential was critical in Donna's opinion since cash was rapidly being used to develop courseware and ABC.com needed to begin to produce more sales and generate a profit. During her interviews she had met with the CEO, Ivan Green, who founded the distance learning company, she found that Ivan was very intellectual and the epitome of an entrepreneur. His entire fortune was tied up in the company and he believed in the concept beyond a doubt. Ivan had recruited the president, Dan Cole, about two years ago. And Jack, the outgoing CFO, seemed like a nice person. Nice people, candid disclosures, a growing industry-ABC.com Company seemed like a perfect fit. Jack had reassured her that, although the company had missed a few of the bank covenants, he had already talked with the bank officers and they were okay with the slight deviation from the original business plan.All this was a relief to Donna because she really needed to focus on the follow-on offering since time was of the essence. Cash was definitely in short supply--even more so than she had suspected before accepting the position. A clean audit opinion and meeting investors' expectations would be key to a successful secondary stock offering. Then Jack revealed something that took Donna completely by surprise. "So, Jack, what you're saying is that Dan doubled the price of our courses last September?""Yup.""But the old price hadn't really been tested yet, had it?" Donna asked."No," Jack said quickly, "but Dan was able to sell the courses at the new price, no problem." "How and to whom? Particularly when sales weren't going all that well at the lower price?" she asked incredulously."Well, a lot of it he bartered. And all of it totally legit," Jack
- 2. seemed proud to say. "How much of it?" she asked. When Jack told her the extent of the bartered revenue she immediately started to get a 7 sinking feeling. What was going on here? Donna now knew the truth about why he was leaving the company. Donna couldn't help but think of the consequences of what she had just uncovered. She believed that although the transactions had theoretically been recorded in accordance with generally accepted accounting principles, those rules were never intended to address companies whose net income--or in this case, net loss--was not important. Accounting for non-monetary transactions required an offset to revenue in the expense line. However, in the world of the dot.com company, revenue was the key figure--not the bottom line. But perhaps even more disturbing was the fact that none of the products or services that Dan had traded had a proven fair market value as far as she could tell. So accurately valuing the transactions was not that easy. Donna confronted Dan with the discovery but he behaved very rudely with Donna and refused to even discuss with her about it. Regardless of the accounting theory, once the bank found out that such a large portion of this year's revenue had nothing to do with bringing in cash they would probably call the note. Of course, the company could not pay it off without a secondary offering. And in just two days the company was scheduled to announce earnings having offered no hint to investors that they would miss the revenue projections. There was no doubt that missing the revenue target this late in the game would cause the stock price to plummet and ultimately eliminate the possibility of a follow-on offering. Donna knew that she was on the verge of getting a reputation for being a troublemaker. Maybe the auditors would figure it out? Maybe it would be best for her to resign her position? It had only been about three weeks and no one would need to know why she left. Besides, she wasn't responsible for last year's numbers anyway. One thing was certain--if the barter revenues were reversed, ABC.com Company would probably not survive. i. ii. Discuss the ethical dilemma faced by Donna in the case given below. If you were in her place what would you do and why? Write a short note on the ethical issues involved in the accounting function and the importance of transparency in disclosure of accounts.