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Conservative Accounting in the General Products Division

This case was written to motivate an ethical discussion of earnings management activities. The example presented here is different from most of those discussed because the earnings management activities described in the case decrease income. That is, the accounting is conservative. Conservatism makes us conclude the actions are ethical. But aren’t managers ultraconservative merely because they want to “save” profits they can turn in a later accounting period if needed.

Questions

Do you approve of Robert’s actions? Are they smart or stupid from the perspective of the division? From the perspective of the corporation?
Are Robert’s actions ethical?
Should Joanne tell anyone of Robert’s request?

CASE
The year 2000 was a good one for the General Products Division (GPD) of Altman Industries, Inc., a large industrial products manufacturer. Sales and profits in the division were significantly above plan due largely to unexpectedly brisk sales of a new product introduced at the end of 1999. The good fortune induced Robert Standish, the GPD general manager, to think about how he could save some of the profits for periods in which he might need them more. He believed that GPD’s plan for 2001 would be tough to achieve because the corporation as a whole was not doing well, and corporate managers would expect GPD to show growth even above this year’s abnormally high sales and profit levels. And already in September, he was sure that his division’s profit would exceed the level above which no additional bonuses were awarded for higher performance-120% of plan-and he wanted to save some of this year’s profits so that he could report them in a year in which they would augment his bonus and those of his direct reports.

Robert asked his staff to do what they could before the end of the year to “stash some acorns” that he could use in future years. He suggested to Joanne, his controller, that she start preparing the pessimistic scenarios that could be used to justify the creation of additional reserves and start thinking about how expenses could be accelerated and revenues deferred at year-end.

Joanne was uncomfortable. She reminded Robert that among the company accounting policies was a statement that assets and reserves should be fairly reported based on the existing facts and circumstances and not be used to manage income. Furthermore, because of continuing order declines, the company was looking for ways to report higher, not lower, profits in the current year and that if the situation did not turn around quickly, layoffs were threatened.

But Robert explained that GPD would still be reporting very high profits; he just wanted to save a portion of the excess above plan. And in any case, GPD couldn’t help the corporation much because it was so small in comparison with the entire corporation.