Your manager asks you to record rent expense for only eight months instead of a year as rent for four months is outstanding and will only be paid in the next fiscal year. He also asks you to record revenue in this fiscal year for an order made by a customer which is supposed to be delivered no earlier than the second week of the next fiscal year. What are the accounting and ethical issues involved? What do you do?
Decrypting the scenario, manager with the request is asking to show lesser expenditure (by not including the rent of four months which was to be paid in this fiscal year) and showing higher revenue (by also including the sales/revenue of the next fiscal year). That’s upright wrong and it does come with accounting and ethical issues as well which are as discussed in the paragraphs to follow.
The obvious ethical issues involved include of false/fraud financial reporting which is by showing records that shouldn’t be there (for sales) and one which should be there but omitted out (like four-month rent). That also has a misinterpretation of the asset as the money which will only come in the next year after the completion of the sales is showed as the asset in this fiscal year statement. Furthermore, more fund is shown to be accumulated such as those supposed to be used in rent is still displayed as the asset itself in the record.
The event will have an impact on the planning for the next fiscal year as the transaction records vary from what it should really be. This becomes an issue for next fiscal year planning due to overestimating for this particular year’s revenue and undervalue of costing. The implication it has on the scenario is that the next year’s growth model will also be overestimated. It may result in the company financing projects that are beyond organizational capacity causing the organization to take loans and not being able to pay them back.
It also has a high chance that the brand image will suffer due to the overflow effect. This means that if the message gets out to the general public, people will lose trust in it. The perception that people have about the brand reduces along with the credibility resulting in business loses. Furthermore, the franchise market value/stock value might plummet. This may even cause the company’s sponsors/investors to pull out.
The business could be fined a penalty for the violation of accounting and ethical laws, which is more strongly followed in the United States. The country also has started practicing Sarbanes-Oxley Act since 2002 which has increased the stake for not getting into such practices (Romano, 2004). And, if discovered they may also have to face criminal charges.
All those reasons mentioned above is why this practice should be strictly avoided and I won’t do what the manager suggest but rather convince him to follow the ethical practice.
Romano, R. (2004). The Sarbanes-Oxley Act and the making of quack corporate governance. Yale Law Journal , 114 , 1521.
There are occasion when higher authority asks you to do something that may contradict your principals on ethical grounds. This happens in real life and many accountants have faced this. Let us discuss on the accounting and ethical issues involved and what can be done.
Accounting issues involved
The rent for four months to be booked in the next fiscal year would be a wrong and the audit is sure to raise questions about it. Expenses shown in this year’s final report will be less and will not show the actual condition of the company. Similarly booking a revenue from sales that has not happened will also show an inflated income which will be interpreted as maximized shareholders wealth. Based on the final accounts the mangers take decision of distribution of dividend and reserve is decided. When income is based on accrual basis interpretation could be unclear. Thus the analysis will not show actual performance of the company and wrong interpretation can be dangerous.
Ethical issues involved
Showing less expenditure and high revenue is ethically wrong. Company’s shares are traded in the secondary market. A lot of investment in poured in this market. Investors base their analysis on the final report and make strategic decisions for purchase of the company. Showing wrong reports will be deceiving these investors. Even if a person has the ability to understand what is ethically acceptable or not, they may behave unethically because of not having or identifying what is ethically wrong. (Taylor, 2013)
Remedy for the situation
"Financial managers seeking to maximize shareholder wealth must also confront difficult ethical dilemmas. (Moyer, McGuigan, Rao, & Kretlow, 2012)” Even though the aim of the corporation is to maximize its profit, decision on ethical dilemmas should be based on what is right and not always on the goal of the organization. Accounts can perform these tasks by showing payable for the rent and receivable for the sale. But if these account have not been mentioned in this related headings and instead not included in the expenses or included directly in the income from sale, then the final account will show a wrong position of the company.
If the entry are not carried out in this way then these entries should be rejected.
Moyer, C. R., McGuigan, J. R., Rao, R., & Kretlow, W. J. (2012). Contemporary Financial Management. Natorp Boulevard: South-Western, Cengage Learning.
Taylor, A. (2013). Ethics training for accountants: does it add up? Meditari Accountancy Research , 161-177. Retrieved from https://proxy.lirn.net/MuseProxyID=mp01/MuseSessionID=co10e3sa9/MuseProtocol=https/MuseHost=search.proquest.com/MusePath/central/docview/1442860632/abstract/C54EBC79F0B04670PQ/3?accountid=158986
In the Accrual Basis of Accounting, the revenue is recorded when earned and expenses are recorded when incurred, regardless of when cash is exchanged. All revenues of the association are reported when earned, not when received. For Example, Members’ Assessments are reported as revenues on the association’s Income Statement (Statement of Revenues and Expenses) when they are charged to the members (i.e., earned by the association, usually on the first day of the month). At the same time, a corresponding asset titled "Assessments Receivable” is reported on the face of the Balance Sheet. As payments are received from the members, they increase the association’s Cash balance while either reducing Assessments Receivable (if the payment is received after the assessment has been charged) or increasing Prepaid Assessments (if the payment is received before the assessment is actually earned) (Mahadi & Khalid, 2017). But all expenses of the association are reported when incurred, not when paid. For Example, The costs of various services that are provided to the association (e.g., bookkeeping, insurance, landscaping, management, utilities, etc.) are reported as expenses on the Income Statement when these services have actually been provided. At the same time, a corresponding liability titled "Accounts Payable” is reported on the face of the Balance Sheet. As these items are paid, the association’s Cash balance and Accounts Payable are reduced (Mahadi & Khalid, 2017).
In my point of view when my manager asked me to keep the record of rent expense for only eight months is logically wrong because in accrual account the revenue is recorded when earned and expenses are recorded when incurred. So that I could not do as per him because it is against of accounting principal and standard. If we keep the record as per manager then we are able to reduce the expenses of this annual years then profit is maximized after that the amount of employee bonus is definitely increased. So that as a professional accountant responsibility is not exclusively to satisfy the needs of an individual client or employer and maximize the profit in a wrong way. But a professional accountant should observe and comply with the ethical requirements of this Code. According to (Meymandi & Rajabdoory, 2015) this Code is in three parts, first is establishes the fundamental principles of professional ethics for professional accountants and provides a conceptual framework for applying those principles, second is the conceptual framework is to be applied in specific situations and the last one applies to professional accountants in business. As a professional accountant, I shall comply with the following fundamental ethics and guidance. These are integrity, Objectivity, Professional Competence, Confidentiality, Professional Behavior and accountability (Jaijairam, 2017). My major duty is not keeping the record only I should follow this as well.
If he/she force me to do this on his/her way then I would inform with stakeholder or senior line manager. For example, if I am working in a Commercial bank as an accountant then my branch manager ask me to record this on this way then I would inform those matter with the senior manager or general manager of our Bank.
Jaijairam, P. (2017). Ethics in Accounting. Research Gate, 48-52.
Mahadi, R., & Khalid, S. (2017). Accrual Accounting in Public Sectors. Asian Journal of Finance & Accounting, 16-21.
Meymandi, A., & Rajabdoory, H. (2015). Ethics in Accounting Job. International Journal of Management, Accounting, and Economics Vol. 2, No. 2, 136-141.
In the given situation, the manger wants us to record the transaction on cash basis. In cash basis, the expenses and revenues are recognized when the cash is paid or received respectively. But this basis is not identified by GAAP as the correct means of recording the financial transactions. So we need to tell the manger that what he wants is not as per the accounting principle so we need to maintain the record on the basis of accrual accounting. In accrual accounting, the income is recognized when it is earned and expenses are recognized when they are incurred without taking the time of payment into consideration (Accounting Tools, 2017).
As per the accrual basis, we need to record the rent for the whole year as expenses though the rent for four months is still outstanding. Similarly the revenue should be recorded in next fiscal year though the order is made in the current fiscal year. If we do as asked by the manager, it will give falsified figure that is against the ethical practices. If we record the transaction on cash basis, it will show higher revenue and less expenses that will show increased profit when the actual scenario is not like that.
However accrual basis requires estimates in some areas that may not deliver the accurate figure. It providesguidance regarding how to account for revenue and expense transactions in the absence of the cash receipts or payments. The accrual basis provides more even recognition to revenues and expense so it is considered as the most valid accounting system for ascertaining results of operations, financial positions and cash flow by the investors and other stakeholders. The accrual basis can give fair and accurate picture of business at any given stage (Vaidya).
Maintaining records on accrual basis helps to follow both the accounting and ethical standards. So we need to tell the manger what he wants is not ethical so it should not be done.
Accounting Tools. (2017). The Accrual Baasis of Accounting. Retrieved from Accounting Tools: https://www.accountingtools.com/articles/what-is-the-accrual-basis-of-accounting.html
Vaidya, D. (n.d.). Accrual Accounting Basis | Top Examples | Advantages Disadvantages. Retrieved from Accounting Basics: https://www.wallstreetmojo.com/accrual-accounting/