Excello Telecommunications: Legality and Ethicality of Financial Reporting - Essay Example

Excello Telecommunications: Legality and Ethicality of Financial Reporting al Affiliation Excello Telecommunications: Legality and Ethicality of Financial Reporting Legal Issues Involved The legal issues involved in the case include the intent to veer away from the revenue recognition principle as prescribed under the Generally Accepted Accounting Principles (GAAP), as well as potential violations on any of the applicable criteria set by the Sarbanes-Oxley (SOX) Act (Mintz & Morris, 2011). The revenue recognition principle stipulates that “revenues are recognized when (a) realized or realizable and (b) earned [SFAC No. 5, Para. 83]” (Revenue Recognition Principle, n.d.). As such, case facts revealed that when Tim Reed, the CFO approached the controller Marty Fuller, both have recognized that they understand the rules regarding recording sales where goods are yet to be delivered in the future. As such, from the perspective of the company, the transaction could be booked as unearned (or deferred) revenue which is actually supposed to be recorded in the books as a liability (Stanford University, 2007). As emphasized, “once earned, the liability is reduced and revenue is recorded in the general ledger” (Stanford University, 2007, p. 1). Therefore, the intention to “come up with a creative way around the rules so that the $1.2 million can be recorded as revenue in 2010” (Mintz & Morris, 2011, p. 58) is a clear violation of the revenues recognition principle under the GAAP. Likewise, there are also indications of potentially violating the SOX Act, specifically the law which requires CPAs to report misstatement or error, where “misstatements or errors include incorrectly recorded financial statement amounts and financial statement amounts that should have been recorded but were not” (Mintz & Morris, 2011, p. 10). In this particular case, if in case Fuller would agree to Reed’s proposal, as the controller, he would be liable to report and disclose the misstatement and be fully accountable for apparent lapses in internal control. As such, the organization could report a financial gain, temporarily, during the fiscal period ending December 31, 2010, but in truth, both are misleading other stakeholders on the accurate financial condition of the organization. Thus, the deception and violation of transparency make them liable to clients and third parties and could even cause them a negative corporate image in the long run for fraudulent recording. Criteria by which Sarbanes-Oxley would Apply to the Case The criteria by which the SOX Act would apply to the case was noted in terms of the potential misstatement in recording the revenue for the period despite knowing that it has not yet been earned. As explicitly noted, there are “four perspectives to help CPAs meet their responsibilities under the act including (1) the actual financial statement misstatement or error, (2) an internal control deficiency caused by the failure in design or operation of a control, (3) a large variance in an accounting estimate compared with the actual determined amount, and (4) financial fraud by management or other employees to enhance a company’s reported financial position and operating results” (Mintz & Morris, 2011, p. 9). From the perspectives, it is clear that Excello Telecommunications would be violating the recording of the revenue recognition principle, as well as the alleged intent to commit financial fraud by the CFO, Tim Reed, to enhance the company’s reported financial condition by the end of the fiscal period December 31, 2010. Financial Reporting Standards Involved and Manner by which Standards were Violated The financial reporting standards required compliance to the revenue recognition principle as stipulated under the GAAP. It was clear from case facts that due to the fact that for the first time in their earnings history, the earnings estimates would not be met, Tim Reed could be questioned by the Board of Directors and members of the executive time as to the reasons which hampered the realization of projected earnings. As such, to avoid embarrassment and inquest, Reed resorted to conniving with Fuller in trying to find out alternative courses of action which could achieve his defined objectives: to record the $1.2 million as revenue in 2010 as well as to ensure that the course of action could be defensible from the perspectives of GAAP (Mintz & Morris, 2011). The standards on revenue recognition and the apparent commission of financial fraud by the CFO to enhance the financial condition of Excello Telecommunications were evident. Financial Reporting Activity in terms of the AICPA Code of Professional Conduct Ethicality of the Events within the Case If and when Fuller would agree to recognize the revenue as earned within the 2010 fiscal year, the action and entry would be a gross violation of the AICPA Code of Professional Conduct (American Institute of CPAs, 2014). Specifically, the accountants would be violating rule 203 of the accounting principles, to wit: “A member shall not (1) express an opinion or state affirmatively that the financial statements or other financial data of any entity are presented in conformity with generally accepted accounting principles or (2) state that he or she is not aware of any material modifications that should be made to such statements or data in order for them to be in conformity with generally accepted accounting principles, if such statements or data contain any departure from an accounting principle promulgated by bodies designated by Council to establish such principles that has a material effect on the statements or data taken as a whole” (American Institute of CPAs, 2014, p. 1). In this situation, the accountants, the controller, and the CFO would violate ethical standards of their profession, specifically the intention to commit financial fraud and the malicious intent to record the revenue when not yet earned. Best Alternative offered by the Team From the three alternatives offered by the accounting team, the following are the analytical evaluation of each option: 1. Transfer the product to an off-site warehouse owned by Excello by December 31 and hold it until January 11 when it would be shipped to Data Equipment. Analysis: Transferring the product to an off-site warehouse owned by Excello by December 31 would not justify recognition of revenue by the fiscal year 2010 since it does not evidence transfer to the goods to Data Equipment Systems. As such, the option still clearly violates the accounting principles on revenue recognition based on the GAAP. Likewise, this is also unethical given the premise that the course of action would be resorted to with the malicious intent of enhancing the financial condition of Excello. Thus, on both the legality and ethicality, the option obviously violates these standards, as well as the accounting standards. 2. Transfer the product to Data Equipment by December 31 and agree that the customer could return it for a full refund after it arrives at Data Equipment’s warehouse. Analysis: The option would require coordination and agreement with Data Equipment regarding the rationale for the proposed course of action. Data Equipment already clearly requested Excello to hold the good until January 11 due to their lack of warehouse to hold the product (Mintz & Morris, 2011). Thus, the fact that Data Equipment could potentially return the product to Excello for lack of space in holding it which does not satisfy the revenue recognition principle (Revenue Recognition Principle, n.d.). Therefore, in legality, the option would not hold. Likewise, in ethicality, it also does not justify the action to be taken due to the intent that this option is resorted to for the purpose of enhancing the financial condition of the company. As such, this option is also not aligned with the accounting standards since it still violates rule 203 of the accounting principles (American Institute of CPAs, 2014). 3. Offer Data Equipment a 10 percent discount to take the product by December 31. Analysis: The course of action is actually potentially viable provided that Data Equipment would be amenable to accept the proposal. Offering a 10% discount is a substantial discount for Data Equipment which could entice them to clear out space and make way for the ordered products. This option is therefore legal, ethical, and aligned with the accounting standards since the action would only take effect if and when Data Equipment would agree to this. However, providing a 10% discount should still be subject to the knowledge and approval of the Board of Directors and full disclosure as to the rationale for offering it must also be revealed. From the three alternative courses of action, it is clear that the third option has the greatest potential for being selected as the most viable option due to its ability to satisfy legality, ethicality and alignment with accounting standards. However, given the time frame for Data Equipment to decide is a consideration at this point (December 30 and a decision had to be made on or before December 31). Likewise, as indicated, the CFO should seek approval and consent from the Board of Directors to provide a 10% discount before the transaction would be implemented. References American Institute of CPAs. (2014). AICPA Code of Professional Conduct . Retrieved from aicpa.org: http://www.aicpa.org/RESEARCH/STANDARDS/CODEOFCONDUCT/Pages/default.aspx Mintz, S., & Morris, R. (2011). Chapter 7 Earnings Management and the Quality of Financial Reporting. In S. M. Mintz, Ethical Obligations and Decision Making in Accounting: Text and Cases. McGraw Hill. Revenue Recognition Principle. (n.d.). Retrieved from accountinginfo.com: http://accountinginfo.com/study/fs/revenue-101.htm Stanford University. (2007). Policy Notes: Revenue Recognition – Auxiliaries and Service Centers. Retrieved from standord.edu: http://web.stanford.edu/group/fms/fingate/staff/fundsmgmt/policy_notes/rev_recog_aux_serv_ctr.html Read More