5. Ethical Dilemma
The chapter contains the following ethical dilemma:
ETHICAL DILEMMA
The Raintree Cosmetic Company has several loans outstanding with a local bank. The debt
agreements all contain a covenant stipulating that Raintree must maintain a current ratio of at
least 0.9. Jackson Phillips, company controller, estimates that the 2018 year-end current assets
and current liabilities will be $2,100,000 and $2,400,000, respectively. These estimates provide
a current ratio of only 0.875. Violation of the debt agreement will increase Raintree’s
borrowing costs as the loans are renegotiated at higher rates.
Jackson proposes to the company president that Raintree purchase inventory of $600,000 on
credit before year-end. This will cause both current assets and current liabilities to increase by
the same amount, but the current ratio will increase to 0.9. The extra $600,000 in inventory will
be used over the later part of 2019. However, the purchase will cause warehousing costs and
financing costs to increase.
Jackson is concerned about the ethics of his proposal. What do you think?
You may wish to discuss this in class. If so, discussion should include these elements.
Step 1—The Facts:
The debt agreements for loans of Raintree Cosmetic Company require the firm to maintain a
current ratio of 0.9. If the company does not maintain the required ratio, borrowing costs on the
loans increase. Jackson Phillips, the controller, estimates that the 2018 current ratio will be
0.875. He proposes making a year-end inventory purchase of $600,000 to increase the current
ratio to 0.9. The purchase of inventory will increase assets, liabilities, and carrying costs. The
inventory will not be sold until late 2019, indicating that the company currently does not need
the goods and that the controller is considering ordering the merchandise solely to improve the
current ratio.
Step 2—The Ethical Issue and the Stakeholders:
The ethical issue or dilemma is whether the controller’s obligation to reduce the company’s
borrowing costs is greater than his obligation to provide information that is not misleading to
users of the financial statements. Users include the bank making the loans.
Stakeholders include Jackson Phillips, controller, the company president, other corporate
managers, company employees, the bank, future creditors, and current and future investors.
Step 3—Values:
Values include competence, honesty, integrity, objectivity, loyalty to the company, and
responsibility to users of financial statements.
Step 4—Alternatives:
1. Purchase the additional $600,000 of inventory in order to maintain the current ratio at 0.9.
2. Refuse to order the additional purchase and maintain the current ratio at 0.875.
3. Ask the bank to keep borrowing costs at the same rate since the current ratio of 0.875 is
close to the required 0.9.
Step 5—Evaluation of Alternatives in Terms of Values:
1. Alternative 1 illustrates loyalty to the company’s effort to maintain the debt covenant and
reduce borrowing costs.
2. Alternative 2 exhibits the values of competence, honesty, integrity, objectivity, and
responsibility to users of the financial statements.
3. Alternative 3 also exhibits the values of competence, honesty, integrity, objectivity, and
responsibility to the bank.
Step 6—Consequences:
Alternative 1
Positive consequences: Jackson may please the president and other top managers by enabling
the company to meet the current ratio agreement. Borrowing costs would remain the same.
Negative consequences: Users of the financial statements, including the bank, may believe
that the company is in a better balance sheet position than is actually the case. The bank would
not receive the correct amount of renegotiated borrowing costs and may sue the company or call
in the debt for immediate payment upon learning the truth. Auditors may refuse to give a positive
opinion on the fair presentation of the financial statements. Jackson may lose the respect of the
president and other top management. He also may lose his job.
Alternative 2
Positive consequences: Users of financial statements would receive more relevant and reliable
information regarding the company’s current ratio and financial position. Jackson would maintain
his integrity, may receive praise for being honest, and may keep his job.
Negative consequences: Jackson may incur the disfavor of the president and the rest of top
management for causing the company to incur increased borrowing costs. He may lose the trust
of other managers and lose his job.
Alternative 3
Positive consequences: The bank may agree to the lower current ratio and not renegotiate
borrowing costs. Jackson would receive the respect of the president and other managers.
Negative consequences: The bank may refuse to accept the lower current ratio and renegotiate
higher borrowing costs. Jackson may incur the disfavor of the president and other top managers.
He may lose his job.
Step 7—Decision:
Student(s) must decide their course of action.
Assignment Chart
Learning Est.
time
Questions Objective(s) Topic
(min.)
3–1 1 Purpose of the balance sheet 5
3–2 1 Usefulness of the balance sheet 5
3–3 2 Current assets 5
3–4 3 Current liabilities 5
3–5 2,3 Operating cycle 5
3–6 2 Current versus noncurrent—investments 5
3–7 2 Property, plant, and equipment 5
3–8 2 Property, plant, and equipment versus intangibles 5
3–9 3 Liability classification 5
3–10 2,3 Paid-in capital and retained earnings 5
3–11 4 Disclosure notes 5
3–12 4 Significant accounting policies 5
3–13 4 Subsequent events 5
3–14 5 Management discussion and analysis 5
3–15 6 Audit report 5
3–16 4 Proxy statement 5
3–17 8 Liquidity ratios 5
3–18 8 Solvency ratios 5
3–19 9 IFRS; balance sheet presentation 5
3–20 9 IFRS; balance sheet presentation 5
3–21 A Segment reporting [Based on Appendix] 5
3–22 A Segment reporting [Based on Appendix] 5
3–23 9,A IFRS; segment reporting; [Based on Appendix] 5
Brief Learning Est.
time
Exercises Objective(s) Topic
(min.)
3–1 2,3 Current versus noncurrent classification 5
3–2 2,3 Balance sheet classification 10
3–3 2,3 Balance sheet classification 5
3–4 2,3 Balance sheet preparation 15
3–5 2,3 Balance sheet preparation 15
3–6 2,3 Balance sheet classification 10
3–7 2,3 Balance sheet preparation; missing elements 10
3–8 4 Financial disclosures 5
3–9 8 Calculating ratios 10
3–10 8 Effect of decisions on ratios 5
3–11 8 Calculating ratios; solving for unknowns 10
Learning Est.
time
Exercises Objective(s) Topic
(min.)
3–1 2,3,8 Balance sheet; missing elements 10
3–2 2,3 Balance sheet classification 10
3–3 2,3 Balance sheet classification 10
3–4 2,3 Balance sheet preparation 15
3–5 2,3 Balance sheet preparation 20
3–6 2,3 Balance sheet; current versus long-term
classification
15
3–7 2,3 Balance sheet preparation; errors 20
3–8 2,3 Balance sheet; current versus long-term
classification
10
3–9 2,3 Balance sheet preparation 30
3–10 4 Financial disclosures 10
3–11 4 Disclosures notes 15
3–12 4 Financial disclosures 10
3–13 4 FASB codification research 15
3–14 2,4 FASB codification research 15
3–15 2,3,4,6 Concepts; terminology 15
3–16 8 Calculating ratios 10
3–17 8 Calculating ratios 30
3–18 8 Calculating ratios; solve for unknowns 25
3–19 8 Calculating ratios; solve for unknowns 20
3–20 8 Effect of management decisions on ratios 20
3–21 A Segment reporting [Based on Appendix] 10
3–22 9,A IFRS; segment reporting [Based on Appendix] 10
Learning Est.
time
Problems Objective(s) Topic
(min.)
3–1 2,3 Balance sheet preparation 15
3–2 2,3 Balance sheet preparation; missing elements 30
3–3 2,3 Balance sheet preparation 30
3–4 2,3 Balance sheet preparation 30
3–5 2,3 Balance sheet preparation 30
3–6 2,3,4 Balance sheet preparation, disclosures 45
3–7 2,3 Balance sheet preparation; errors 35
3–8 2,3 Balance sheet; errors; missing amounts 40
3–9 2,3 Balance sheet preparation 30
3–10 2,3 Balance sheet preparation 30
Star Problems
Learning Est.
time
Cases Objective(s) Topic
(min.)
Communication Case 3–1 2 Current versus long-term classification 10
Analysis Case 3–2 2,3 Current versus long-term classification 15
Communication Case 3–3 2 FASB codification research; inventory or
property, plant, and equipment
20
IFRS Case 3–4 2,3,9 Balance sheet presentation; Vodafone Group, Plc. 20
Judgment Case 3–5 2,3,4 Balance sheet; errors 30
Judgment Case 3–6 4 Financial disclosures 15
Real World Case 3–7 2,3,4,8 Balance sheet and significant accounting policies
disclosure; Walmart 20
Judgment Case 3–8 4 Post fiscal year-end events 15
Research Case 3–9 4 FASB codification; locate and extract relevant
information and cite authoritative support for a
financial reporting issue; related-party
disclosures; Enron Corporation
35
Real World Case 3–10 4,5 Disclosures; proxy statement; Coca-Cola 45
Judgment Case 3–11 7 Debt versus equity 25
Analysis Case 3–12 4,6,7,8 Obtain and critically evaluate an actual annual
report
50
Analysis Case 3–13 4,7,8 Obtain and compare annual reports from
companies in the same industry 95
Analysis Case 3–14 2,3,4 Balance sheet information; Target 15
Analysis Case 3–15 9,A Segment reporting concepts [Based on Appendix] 15
Ethics Case 3–16 A Segment reporting [Based on Appendix] 20
Target Case 2,3,8 Balance sheet presentation, risk ratios; Target
15
Air France–KLM Case 9 IFRS; balance sheet presentation; Air
France-KLM 15