Case 2-8
Juggyfroot
“I’m sorry, Lucy. That’s the way it is,” Ricardo Rikey said.
“I just don’t know if I can go along with it, Rikey,” Lucy replied.
“We have no choice. Juggyfroot is our biggest client, Lucy. They’ve warned us that they will put the engagement
up for bid if we refuse to go along with the reclassification of marketable securities,” Rikey explained.
“Have you spoken to Fred and Ethel about this?” Lucy asked.
“Are you kidding? They’re the ones who made the decision to go along with Juggyfroot,” Rikey responded.
The previous scene took place in the office of Deziloo LLP, a large CPA firm in Beverly Hills, California. Lucy
Spheroid is the partner on the engagement of Juggyfroot, a publicly owned global manufacturer of pots and pans and
other household items. Ricardo Rikey is the managing partner of the office. Fred and Ethel are the two members of
the firm that make final judgments on difficult accounting issues especially when there is a difference of opinion
with the client. All four are CPAs.
Ricardo Rikey is preparing for a meeting with Norman Baitz, the CEO of Juggyfroot. Rikey knows that the
company expects to borrow $5 million next quarter and it wants to put the best face possible on its financial
statements to impress the banks. That would explain why the company had reclassified a $2 million market loss on a
trading investment to the available-for-sale category so that the “loss” would now show up in stockholder’s equity
and not as a charge against current income. The result was to increase earnings in 2013 by 8 percent. Rikey also
knows that without the change, the earnings would have declined by 2 percent and the company’s stock price would
have taken a hit.
In the meeting, Rikey points out to Baitz that the investment in question was marketable and in the past the
company had sold similar investments in less than one year. Rikey adds there is no justification under generally
accepted accounting principles to change the classification from trading to available-for-sale.
NOTES
This case shows how the simple miss-classification of an item on the balance sheet can trigger earnings effects even
though the equity of the company is unaffected. It also illustrates how alternative treatments under GAAP can be
used to manage earnings.
Ethical Issues
Rights Theory: It is not right to mislead the investors by making it look as though the company is doing better than it
really is. Any attempt to intentionally misstate the financial statements violates the categorical imperative. Users
(i.e., creditors) have a right to accurate and reliable financial information prior to making loan decisions.
Justice Theory: Stakeholder interests are not fairly represented because the perceived interests of the management
are given priority over the interest of all other stakeholders. Each group has an equal right to accurate and reliable
statements to assist in their decision making.
Utilitarian Theory: Rule-utilitarianism: It requires that the correct rule should be followed. The correct rule is to
follow GAAP and report financial information honestly. Act-utilitarianism: Requires that the act that creates the
greatest good for the greatest number of stakeholders should be selected. None of the stakeholders benefit from an
action that misstates net income. Even Juggyfroot is potentially harmed because the SEC may impose sanctions on it
for false and misleading financial statements. If the loan is made based on false data, it may come back to haunt the
company later on.
Virtue Theory: Honesty requires that the statements should be truthful and the statements should be trustworthy and
prepared diligently, with objectivity and integrity. Objectivity requires that the company should approach its
decision about the proper asset classification with fair-mindedness and without partiality to one set of stakeholders.
Trustworthiness means that the accountants should not violate the investors’ faith that the statements are accurate
and reliable. Integrity requires that Rikey should have the moral courage to withstand Baitz’s pressure – not
subordinate professional judgment to the client as would a person of integrity.
Questions
1. Explain the rules in accounting to determine whether an investment in a marketable security should be
accounted for as trading, available-for-sale, or held-to-maturity. Include in your discussion how such
classification affects the financial statements.
Statement of Financial Accounting Standards No. 115 requires that investments be classified in three categories and
accounted for as follows:
Debt securities that the enterprise has the positive intent and ability to hold to maturity are classified as
Debt and equity securities that are bought and held principally for the purpose of selling them in the near
Debt and equity securities not classified as either held-to-maturity securities or trading securities are
classified as available-for-sale securities and reported at fair value, with unrealized gains and losses
2. Who are the stakeholders in this case? What expectations should they have and what are the ethical
obligations of Deziloo and its CPAs to the stakeholders? Use ethical reasoning to answer this question.
The stakeholders of this case are the bank, the shareholders, creditors, suppliers, employees, and officers of the firm.
The stakeholders expect accurate and reliable financial statements. Deziloo has an obligation to perform the audit
with integrity, objectivity, and due professional care. From a rights perspective, it is not right to mislead the
investors by making it look as though the company is doing better than it really is. Any attempt to intentionally
misstate the financial statements violates the categorical imperative. From a justice perspective, stakeholder interests
None of the stakeholders benefit from an action that misstates net income. Even Juggyfroot is potentially harmed
because the SEC may impose sanctions on it for false and misleading financial statements. From a virtue
perspective, honesty requires that the statements should be truthful and recognize revenue under GAAP. Objectivity
3. Using the AICPA Code of Professional Conduct as a reference, what ethical issues exist for Rikey, Lucy,
Fred and Ethel, and Deziloo LLP in this matter? What role does auditor virtue play in determining what to
do in this case?
Under the AICPA Code, the ethical issues are summarized in the principles of the Code, Articles I (Responsibilities),
II (The Public Interest), III (Integrity), IV (Objectivity and Independence) and V (Due Care). If the firm should
succumb to pressure from Baitz and Juggyfroot, then the firm has committed an act discreditable to the profession