Mike Crane, an audit senior at a prominent public accounting firm, has encountered a complex ethical dilemma in his audit engagement with Frost Corporation, a longstanding client in the commercial construction industry. The situation revolves around the company’s practice of making unusual accounting changes to the useful lives of its fixed assets, particularly altering these estimates significantly near the midpoint of their original projections (Kieso, Weygandt, & Warfield, 2017). The repercussions of these accounting changes raise several ethical concerns, affecting stakeholders both within and outside the organization.
Question 1: Ethical Issues Concerning Frost’s Practice
The practice of altering the useful lives of fixed assets, as observed in Frost Corporation’s accounting records, raises a multitude of ethical concerns that reverberate through the core principles of accounting ethics. These concerns stem from the inherent duty of accountants to provide accurate and transparent financial information to stakeholders, ensuring the faithful representation of a company’s financial position and performance (Kieso et al., 2017). Analyzing this situation under the lens of ethical considerations unveils various dimensions of the issue.
Misrepresentation of Financial Performance
At the heart of the ethical dilemma lies the blatant misrepresentation of financial performance through the manipulation of accounting estimates. The primary objective of financial reporting is to present a fair and accurate view of a company’s financial health to external users, aiding them in making informed decisions (Kieso et al., 2017). Altering the useful lives of fixed assets artificially inflates earnings by reducing depreciation expenses, which can lead to an inaccurate portrayal of the company’s actual performance. Such practices distort the underlying economic reality and contradict the principle of faithful representation (Kieso et al., 2017). Ethically, this poses a significant concern as it undermines the trust and reliance stakeholders place in financial statements.
Violation of Transparency and Accountability
Transparency is an ethical cornerstone of financial reporting that necessitates the clear and comprehensive communication of relevant information to users. Stakeholders, including investors, creditors, and regulatory bodies, rely on this information to assess a company’s financial position and prospects accurately (Kieso et al., 2017). By artificially lowering the useful lives of assets without appropriate economic justification, Frost Corporation erodes transparency. The lack of transparency disrupts stakeholders’ ability to evaluate the company’s long-term sustainability, investment potential, and risk exposure. This ethical breach further extends to accountability, as stakeholders hold the company responsible for delivering truthful and reliable financial information (Kieso et al., 2017).
Integrity and Professionalism
Accounting professionals are bound by a code of ethics that underscores their responsibility to act with integrity and uphold the standards of the profession (Kieso et al., 2017). The ethical issues arising from Frost’s accounting practices encompass not only the distortion of financial information but also the erosion of the accounting profession’s integrity. Accounting is built on a foundation of trust, where the competence, objectivity, and ethical behavior of accountants are vital for maintaining public confidence (Kieso et al., 2017). Frost’s practices compromise this integrity by prioritizing short-term gains over the profession’s ethical values.
Implications for Stakeholders and the Market
The consequences of Frost’s accounting changes extend beyond ethical concerns, impacting various stakeholders and market dynamics. Investors who rely on accurate financial information to make informed decisions face potential losses due to misrepresentations. Creditors, in evaluating the company’s creditworthiness, might base their decisions on inaccurate data, leading to unfavorable lending terms. The misrepresentation also raises the risk of regulatory intervention and legal consequences, diminishing the company’s reputation and potentially affecting its market value (Kieso et al., 2017).
Question 2: Harmed Parties by Frost’s Accounting Changes
Several parties could be adversely affected by Frost Corporation’s unusual accounting changes.
Investors and Shareholders: Investors rely on accurate financial information to assess the company’s performance and make investment decisions. Manipulating accounting estimates to inflate earnings can mislead investors into believing that Frost is performing better than it actually is. Consequently, investors may make decisions based on distorted information, leading to financial losses.
Creditors: Creditors extend loans and credit based on a company’s financial health. Misleading financial statements can affect creditors’ decisions to provide financing or adjust the terms of existing agreements, potentially causing financial distress for Frost if its true financial condition is masked.
Employees: Employees’ job security and compensation can be influenced by a company’s financial performance. Manipulating earnings through accounting changes might impact the company’s ability to provide fair compensation and stable employment conditions.
Regulators and Compliance Agencies: Regulatory bodies, such as the Securities and Exchange Commission (SEC), mandate accurate and transparent financial reporting to ensure market integrity. Frost’s accounting practices could result in regulatory scrutiny, legal consequences, and reputational damage.
Overall Market Confidence: The broader market’s trust in financial reporting and corporate practices can be eroded if instances of misleading financial statements become prevalent. This can undermine the stability and efficiency of financial markets.
Question 3: Mike Crane’s Course of Action
Mike Crane faces a challenging ethical dilemma as he navigates this situation. In light of the ethical issues and potential harm caused by Frost’s accounting changes, Crane has a responsibility to uphold the integrity of financial reporting and act in the best interest of all stakeholders involved. To address this situation effectively, Crane should consider the following steps:
Gather Evidence: Crane should thoroughly investigate the accounting changes, seeking detailed explanations for the alterations to the useful lives of fixed assets. This will provide a comprehensive understanding of the company’s motives and the potential impact on financial statements.
Consult Senior Management: Crane should engage in a discussion with senior management at Frost, including the accounting manager Kevin James. This dialogue can provide insights into the rationale behind the changes and the company’s attitude toward financial reporting integrity.
Refer to Professional Standards: Crane should refer to the professional standards of auditing and accounting, as outlined in the resource provided (Kieso et al., 2017). These standards serve as a guiding framework for ethical conduct and decision-making in auditing engagements.
Report to Supervisors: If Crane finds evidence that the accounting changes are intentionally misleading and violate accounting standards, he should report his findings to his own firm’s higher management. They can provide guidance on how to proceed and may decide to escalate the matter to regulatory authorities if necessary.
Maintain Independence: Throughout the process, Crane should ensure his independence and objectivity in conducting the audit. His primary duty is to provide a fair and accurate assessment of Frost Corporation’s financial statements.
In conclusion, Frost Corporation’s practice of changing the useful lives of fixed assets raises significant ethical concerns that encompass transparency, accountability, and faithful representation in financial reporting. The potential harm extends to investors, creditors, employees, regulatory bodies, and market confidence. Mike Crane must approach this situation with ethical integrity, gathering evidence, consulting relevant resources, engaging with senior management, and reporting to his own firm’s supervisors as necessary. By doing so, Crane can uphold the principles of responsible auditing and financial reporting, promoting transparency and trust in the accounting profession.
Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2017). Financial accounting and accounting standards. Intermediate accounting (17th ed.). John Wiley & Sons, Inc.