Ethics Case 4-7 – Income Statement Presentation of Unusual Loss
The Cranor Corporation suffered $10 million in expenses linked to a product recall. The company had endured product recalls in the past and they still occur in the business. To show revenue from continuing operations, Jim Dietz, the controller, wishes to describe the $10 million as an extraordinary loss, instead of an expense included in operating income. He states to the CEO that the company has never had a product recall of this size and that the corporation fixed the design flaw and improved quality control.
The drawback is, in order for Jim to categorize the loss as an extraordinary item, he must view that the losses in the company’s financial statements are infrequent and unusual. He must also presume this event is not likely to occur again in the future profitability. (Spiceland, Sepe, & Nelson, 2013, p. 188) The Journal of Accountancy states that extraordinary items are gains and losses that are material, and result from events that are both unusual and infrequent.
(Extraordinary Items Share Exclusive Company , 2013) These criteria must be considered in light of the environment in which the entity operates. There obviously is a considerable degree of subjectivity involved in the determination. The concepts of unusual and infrequent require judgment. In making these judgments, an accountant should keep in mind the overall objective of the income statement. The key question is how the event relates to a firm’s future profitability. If it is judged that the event, because of its unusual nature and infrequency of occurrence, is not likely to occur again, separate reporting as an extraordinary item is warranted.
The ethical dilemma faced by Jim Dietz and the company’s chief executive officer is that it appears from the facts of the case that it would be difficult for the company to come to the conclusion that a material product recall is not likely to occur again in the foreseeable future. This type of event has occurred before and is common in the industry. While a subjective judgment, extraordinary treatment of the $10 million does not appear warranted. Is the obligation of Jim and the CEO to maximize income from continuing operations, the company’s position on the stock market and management bonuses stronger than their obligation to fairly present accounting information to the users of financial statements? If they decide to go with Jim’s suggestion, it would be misleading to the shareholders and creditors about the lost suffered. The misrepresenting of the stakeholders and money market would be sinful and display wickedness, while if the corporation is straightforward with the market and shareholders it will demonstrate moral values and show that the corporation is working in the best interest of the investors by not misleading them when it comes to losses. In Exodus 23:1-2 it speaks about bearing a false report.
The New International Version states: “Do not spread false reports. Do not help a guilty person by being a malicious witness. Do not follow the crowd in doing wrong.” With Jim and the CEO being in a management position, they are required to perform many activities in running the entity in the best interest of stakeholders. Their duties include leading and directing an entity, including making important decisions concerning the acquisition, deployment and control of human financial, physical and intangible resources. They are supposed to take the charge for the preparation and fair presentation of the financial statements in accordance to the accounting policies. (Handbook of the Code of Ethics for Professional Accountants, 2013)
I think the Cranor Company should include the loss in their net income and continue with the product recall. Including the loss in their net income will show honesty to its stakeholders. They may not receive a bonus, but it is better for them to be honest than risk the consequences of lying about the loss. Leviticus 19:11 says, “Do not steal. Do not lie. Do not deceive one another. (The Quest Study Bible, New International Version, 1994) By seeing the scripture we can detect how this relates to accounting ethics. Leviticus 19:11 explains that that we are not to steal, and ultimately mislead others. When we associate this verse to this ethical dilemma it would describe Jim Dietz and the company chief executive officer of deceiving the stock market into thinking that the loss was truly an extraordinary item on income statement when in reality, they are misleading them to get a bonus.
The Quest Study Bible, New International Version. (1994). Grand Rapids: Zondervan Publishing House. Extraordinary Items Share Exclusive Company . (2013, September 3). Retrieved from Journal of Accountancy: http://www.journalofaccountancy.com/Issues/2007/May/ExtraordinaryItemsShareExclusiveCompany.htm Handbook of the Code of Ethics for Professional Accountants. (2013). New York: International Federation of Accountants. Spiceland, D., Sepe, J., & Nelson, M. (2013). Intermediate Accounting (7th ed.). New York: McGraw-Hill/Irwin.