EXERCISE 2-13 (15 MINUTES)

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)