Case 7-3
Cubbies Cable
Ernie Binks is a big baseball fan, so it is quite natural for him, at a time like this, to recall a phrase
attributed to Yogi Berra: “It was déjà vu all over again.”
Binks is the partner in charge of the Cubbies Cable audit for the accounting firm of Santos & Williams
LLP. Cubbies is a family-owned regional cable company headquartered in Chicago.
A situation arose with the client over the proper accounting for cable installation costs in the year-ended
September 30, 2013, financial statements. The client wants to expense the costs while the audit manager
has recommended capitalization. It is important to resolve the issue quickly because the client will use the
September 30, 2013, audited annual statements to apply for a $10 million loan at one of two banks –
Chicago First National or Bankers Trust. Binks reviewed a memorandum prepared by John Kessinger, the
audit manager that details the accounting issues, This memo is presented in Exhibit 1.
Exhibit 1
Memo on Capitalization of Cable Equipment
October 15, 2013
We have audited the financial statements of Cubbies Cable
since
September 30, 2008. The
audited statements are typically used by
banks
in granting short-term
loans
to Cubbies Cable.
During the 12-month period ending September 30, 2013, Cubbies constructed a major
new cable system in parts of Chicago that enabled it to
increase
its
presence
in that market.
The revenue from the system through September 30, 2013,
exceeded
projections by more
than 20 per
cent.
A difference of opinion
arose
over the proper accounting for cable construction
costs.
The
client wants
to
expense
all of the
costs
during the year in the quarter ended September 30,
2013.The alternative position we recommend is to capitalize the
costs
and amortize them over
the estimated life of the cable system.
Two different types of
costs
were
involved:
Cable television plant:
Costs associated
with constructing the cable installation project.
SFAS
51,
Financial
Reporting
by
Cable Television Companies,
requires that cable television plant
costs
incurred during
the prematurity
(i.e., construction) periods be capitalized in full. We
had protracted
discussions
with Cubbies Cable regarding this
issue,
and we were told that
there
was
no way the company would agree to capitalize any of
the
costs.
Interest
cost: The client initially
expensed
all interest
costs
related to a construction loan
during
the
prematurity period. We convinced the client to change its accounting to capitalize
the interest
costs
during
the construction period. We used for support our
reference
to
SFAS
51.
This
statement requires
application
of
SFAS
34,
Capitalization
of
Interest Cost,
to interest
costs
incurred during the construction of an
asset.
The application of paragraphs 13 and 14 of
SFAS
34 to the
client’
s
situation requires that interest
costs
incurred during the prematurity
period be capitalized in full by applying the interest capitalization rate to the average amount
of accumulated expenditures for the assets during the period. The purpose of this procedure
is to capitalize the amount of interest costs incurred during the prematurity period that
theoretically could have been avoided if expenditures for construction of the cable television
plant had not been made.
The revenue earned from the cable installation job enabled the company to complete the fourth quarter
of 2013 with record earnings. Revenues at September 30, 2013, exceeded revenues at September 30, 2012,
by 22 percent. Net income for the twelve months ended September 30, 2013, was 24 percent above the
same amount in the prior year.
Binks is now preparing for a meeting with Rod Hondley, the advisory partner on Cubbies Cable audit.
Hondley has already made it known that he supports the client’s position the cable installation costs. Binks
knows Santos & Williams operates by the simple philosophy that you have to let the client win one
somewhere along the line or you may lose that client. The dilemmas for Binks is he is in the uncomfortable
position of going against the recommendation of the audit manager if he agrees to the client’s position that
Hondley supports.
Binks thinks about the fact that the situation is unique in that the client’s preferred accounting treatment
would actually lower earnings for the year-ended September 30, 2013, and increase it in subsequent years.
He considers his options and reflects on another “Yogi-ism”: “When you come to a fork in the road, take
it.”
Ethical Issues
Binks should not stand idly by and compromise his integrity by allowing the firm to
support the client’s position that is not in conformity with GAAP. He will be violating
his ethical and professional obligations if he does so. If the firm does not have any mechanism
in place to review internal differences of opinion on accounting matters, then Binks will have to decide
whether he feels strongly enough about this matter to resign as a partner and sell his partnership interest.
On a practical level, this probably would not occur. From an ethical perspective, however, Binks needs to
weigh his loyalty obligation to the accounting firm against the need to honor the public trust and his audit
manager who suggests following GAAP. If he reasons at stage 4, then he will find it difficult to stand idly
by while the GAAP rules are violated. Binks may have no other option but to resign from the accounting
firm, just as a controller might be expected to do the same if there is a difference of opinion on an
accounting issue with top management of a company.
An interesting aspect of this case is the Dodd-Frank Financial Reform Act allows an auditor to blow the
whistle on wrongdoing by her firm once all avenues of internal appeal are exhausted. You might ask
students if Binks would violate his confidentiality obligation if he blows the whistle under Dodd-Frank.
The issue of confidentiality is an important one for CPAs who have an ethical obligation under the AICPA
Code of Professional Conduct not to divulge client confidential information unless under a valid court order
or subpoena to do so, for ethics investigations of the CPA’s services, peer reviews, or if disclosure is
approved by the client. The question of whether reporting to the SEC under Dodd-Frank under the conditions
explained above would violate the confidentiality obligation of a CPA can be answered by referring to
Rule 301 of the AICPA Code. In addition to the aforementioned exceptions, the rule specifies that the
confidentiality obligation “does not prohibit a member’s compliance with applicable laws and government
regulations,” which presumably would include SEC regulations and Dodd-Frank.
The confidentiality obligation of internal accountants and auditors who are members of the IMA provide
that confidential employer information should be kept confidential except when disclosure is authorized or
legally required. The legal requirement aspect would once again seem to protect the whistleblower given
Dodd-Frank requirements.
This is a good opportunity to review the provisions of Dodd-Frank that were discussed in chapter 3.
CPAs who receive information about potential violations of a client or its directors or officers through an
audit or other engagement required under the federal securities laws are not eligible to receive whistleblower
awards. The SEC included this exclusion so as not to undermine the legal duty that auditors have under
Section 10A of the Securities and Exchange Act of 1934 to report illegal acts by officers, directors, and other
client personnel up the chain of command. If the issues are not addressed adequately by management, the
auditor must then resign from the engagement and file a report with the SEC.
Notably, the whistleblower exclusions do not apply to CPAs who report information about potential
violations regarding their own firms’ performance of audit services for a client. This is true even where the
CPA’s information about his or her firm leads to a successful enforcement action against one of the firm’s
clients.
Questions
1. What do you think was the motivation for Cubbies Cable in taking the position to expense all
cable costs during the year ended September 20, 2013? Would you characterize the position as an
attempt to manage earnings? Why or why not?
If Cubbies Cable was a privately-owned regional cable company, the motivation to expense rather than
capitalize might be motivated by the desire to minimize taxes. Since Cubbie Cable is publicly traded, the
position to expense rather than capitalize does seem to be managing earnings. The big increase in revenues
2. Who are the stakeholders in this situation? Identify the major ethical issues that should be of
concern to Binks in deciding whether to just go along with the firm in its support of the client
(based on Hondley’s position) or support the position of the audit manager. What would you do at
this point if you were in Binks’s position? Why?
The stakeholders are the shareholders, creditors, suppliers, customers, public, regulators and the family
member owners.
The ethical issue for Binks is does he go along with the firm on this matter or should he try to do something
to influence the firm’s position. If he supports the firm, will it be an active and open expression of support
If the firm does not have any mechanism in place to review internal differences of opinion on accounting
matters, then Binks will have to decide whether he feels strongly enough about this matter to resign as a
partner and sell his partnership interest. On a practical level, this probably would not occur. From an ethical
perspective, however, Binks needs to weigh his loyalty obligation to the accounting firm against the need to
3. Do you think it is ethical for CPAs to “horse trade” when negotiating with a client
about the proper GAAP to apply in a particular situation? How does such
negotiating relate to the accepted auditing standards of the AICPA and PCAOB
discussed in Chapter 5?
CPAs should not horse trade when dealing with a client about the proper GAAP. If the CPAs should engage
in horse trading with the client on accounting issues, then their integrity, independence, and objectivity has
been compromised in subordinating judgment to the client’s pressures. However, CPAs can use materiality
