2. The discussion below is divided into two parts—Gallant’s actions to post-
pone expenditures and the actions to reclassify period costs as product
costs.
The decision to postpone expenditures is highly questionable. It is one
thing to postpone expenditures due to a cash bind; it is quite another to
postpone expenditures in order to hit a profit target. Postponing these
expenditures may have the effect of ultimately increasing future costs
and reducing future profits. If orders to the company’s suppliers are
changed, it may disrupt the suppliers’ operations. The additional costs
may be passed on to Gallant’s company and may create ill will and a
feeling of mistrust. Postponing maintenance on equipment is particularly
questionable. The result may be breakdowns, inefficient and/or unsafe
operations, and a shortened life for the machinery.
Interestingly, in a survey of 649 managers reported in Management Ac-
counting , only 12% stated that it is unethical to defer expenses and
thereby manipulate quarterly earnings. The proportion who felt it was
unethical increased to 24% when it involved annual earnings. Another
41% said that deferring expenses is a questionable practice when it in-
volved quarterly reports and 35% said this when annual reports were
involved. Finally, 47% said that it is completely ethical to manipulate
quarterly reports in this way and 41% gave the green light for annual
reports. (See William J. Bruns, Jr. and Kenneth A. Merchant, “The Dan-
gerous Morality of Managing Earnings,” Management Accounting , Au-
gust 1990, pp. 22-25)
Problem 2-23 (continued)
Gallant’s decision to reclassify period costs is not ethical—assuming that
there is no intention of disclosing in the financial reports this reclassifica-
tion. Such a reclassification would be a violation of the principle of con-
sistency in financial reporting and is a clear attempt to mislead readers
of the financial reports. Although some may argue that the overall effect
of Gallant’s action will be a “wash”—that is, profits gained in this period
will simply be taken from the next period—the trend of earnings will be
affected. Hopefully, the auditors would discover any such attempt to
manipulate annual earnings and would refuse to issue an unqualified
opinion due to the lack of consistency. However, recent accounting
scandals may lead to some skepticism about how forceful auditors have
been in enforcing tight accounting standards.
Problem 2-24 (60 minutes)
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