Question

(Ethical Issues—Compensation Plan)

The executive officers of Rouse Corporation have a performance-based compensation plan. The performance criteria of this plan is linked to growth in earnings per share. When annual EPS growth is 12%, the Rouse executives earn 100% of the shares; if growth is 16%, they earn 125%. If EPS growth is lower than 8%, the executives receive no additional compensation.

In 2014, Joan Devers, the controller of Rouse, reviews year-end estimates of bad debt expense and warranty expense. She calculates the EPS growth at 15%. Kurt Adkins, a member of the executive group, remarks over lunch one day that the estimate of bad debt expense might be decreased, increasing EPS growth to 16.1%. Devers is not sure she should do this because she believes that the current estimate of bad debts is sound. On the other hand, she recognizes that a great deal of subjectivity is involved in the computation.

Instructions

Answer the following questions.

(a)  

What, if any, is the ethical dilemma for Devers?

(b)  

Should Devers's knowledge of the compensation plan be a factor that influences her estimate?

(c)  

How should Devers respond to Adkins's request?

Answer 1

Part A

The changing estimates for benefit of Adkins and company’s other executives is completely unethical and unprofessional behaviour. Due to making changes in EPS growth rate, Devers may be put into the critical condition and also stockholders’ would demand for bonuses. No factor should be influence the EPS growth estimates. The following the accounting professional code, Devers should act ethically by doing right things.

Part B

The basis of estimates should not be influence by the compensation plan. It is an ethical duty of Joan Devers that she makes Adkins aware of GAAP requirements associated with the immediate reporting of a percentage of a bad debt expense. She should also inform regarding the timey evaluation of outstanding accounts receivable. She should not lie regarding the bad debt expense and state that reporting of bad debt expense is correct arithmetically and is as per standards.

Part C

It is difficult to know with accuracy the accounts that will go into default and therefore, three methods are used to estimate bad debt expense. They are percentage of credit sales method, the percentage of ending accounts receivable method and the aging of accounts receivables methods. The bad debt expense calculated using any one of the methods method is valid according to the standards. Thus, Joan Devers should not make any changes in the bad debt expense to change the estimates of EPS growth. If she is caught making any changes in the bad debt expense to make change in EPS growth rate, then she may lose her job, penalty or fine may be charged on her and in the worst case she may be jailed. The credit policy may reviewed by the executives to get higher EPS. Therefore, Adkin’s request should be rejected by Joan Devers.