Booking the Budget

[vc_row][vc_column width=”1/1″][vc_tabs style=”tab-style-one”][vc_tab title=”Case” tab_id=”1424769176-1-24″][vc_column_text]Topic: Revenue Recognition

Characters: Connie, President Bob, Vice President of Finance Andy, Controller

Maria, Director of Financial Analysis

Maria and Andy worked well together to organize the accounting system and records of a growing Health Maintenance Organization (HMO). Bob and Connie, the two top executives in the HMO, were tightly focused on company growth as it related to monthly and yearly revenue. Bob was also in charge of budget reports.

Every month Maria and Andy would compile financial statements which were reviewed by company officers and later reported in patient and employee newsletters. Oftentimes sales would fall below Bob’s original projections. At such times, Bob would rant and rave about the low patient revenue accruals and comment “that surely more must be accrued.” Andy and Maria would often remark to each other “why don’t we just book the budget,” since that is essentially what they did every month after their initial financial figures were reviewed, at least in terms of sales.

Although Andy and Maria realized that at year-end the auditors would not condone Bob’s recording practices, they were still somewhat angry that “their” precise accounting system required monthly adjustments because of Bob and Connie’s need to “look good to the board. ”

Of course, when year-end came, the glowing financial news fell short of projections. Although the shortfall was not enough to raise the HMO rates, it did send a panic through the accounting department. This information was not reported directly to shareholders, but it was embarrassing to make the year-end adjustments while scrambling to uncover additional revenues; and explain to coworkers why monthly newsletters were incorrect.

Author: G. Stevenson Smith, Ph.D., CPA, CMA, Professor of Accounting, West Virginia University

Co-author: Curtis Jay Bonk, Ph.D., CPA, Assistant Professor of Educational Psychology, West Virginia University[/vc_column_text][/vc_tab][vc_tab title=”Key teaching notes” tab_id=”1424769176-2-91″][vc_column_text]What Are the Relevant Facts?

  1. Maria and Andy have organized and are responsible for the accounting system of the HMO.
  2. Bob and Connie, executive officers of the HMO, are mainly concerned with rosy sales results.
  3. Financial sales accruals have been recorded for numbers that are closer to budget projections than actual sales.
  4. Auditors reviewing the financial figures will require adjustments to the inflated sales accruals.

What Are the Ethical Issues?

  1. To what extent are Maria and Andy responsible to take action to curtail the recording of budgeted sales?
  1. To what extent are the auditors responsible for supporting better interim accruals of sales?
  2. To what extent is there an obligation by the company to ensure that only correct data about financial results is recorded and disseminated?

Who Are the Primary Stakeholders?

What Are the Possible Alternatives?

  1. Maria and Andy can inform Bob of their dissatisfaction.
  2. Maria and Andy can start a process to develop a formal mechanism, i.e., an ethics committee, to consider ethical issues within the firm.
  3. Maria and Andy can ascertain whether Connie and the Board are completely aware of the practice.
  4. Maria and Andy can inform the auditors and ask them to make financial recommendations about the practice.
  5. Maria and Andy can begin to look for new jobs.
  6. Maria and Andy can do nothing.

What Are the Ethics of the Alternatives?

  1. Do readers of the newsletter have a right to expect unbiased financial reporting?
  2. Do Maria and Andy have any obligations that require them to prepare accurate interim financial reports?
  3. Does the board have a right to receive accurate financial reports?
  4. Do Maria and Andy have a right to be able to approach their superiors about an issue like this without fear of reprisal?
  5. Is there an inequitable burden imposed on readers of the financial data?
  6. Is there an unfair benefit received by those who endorse the current financial reporting practices?
  7. Is there a cost to the accounting profession from financial reporting of this nature?

What Are the Practical Constraints?

  1. Everybody knows that interim reporting is “just a bunch of estimates” anyway.
  2. Maria and Andy have no authority to make the decisions they want to make.
  3. Maria and Andy may be fired if they decide to talk to Bob about their concerns.
  4. The auditors are hired by the HMO, and they may already be aware of the practice.

What Actions Should Be Taken?

  1. What action would you take if you were Maria or Andy?
  2. Which ethical theory (utilitarian, rights, justice) best justifies your decision?

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