Pendleton Automotive Corp.

at
Categories
Tags

 

Pendleton Automotive Corp. is a medium-sized wholesaler of automotive parts. It has 10 stockholders who have been paid a total of $1 million in cash dividends for 8 consecutive years. The board’s policy requires that, for this dividend to be declared, net cash provided by operating activities as reported in Pendleton Automotive’s current year’s statement of cash flows must exceed $1 million. President and CEO Hans Pfizer’s job is secure so long as he produces annual operating cash flows to support the usual dividend.

At the end of the current year, controller Kurt Nolte presents president Hans Pfizer with some disappointing news: The net cash provided by operating activities is calculated by the indirect method to be only $970,000. The president says to Kurt, “We must get that amount above $1 million. Isn’t there some way to increase operating cash flow by another $30,000?” Kurt answers, “These figures were prepared by my assistant. I’ll go back to my office and see what I can do.” The president replies, “I know you won’t let me down, Kurt.”

Upon close scrutiny of the statement of cash flows, Kurt concludes that he can get the operating cash flows above $1 million by reclassifying the proceeds from the $60,000, 2-year note payable listed in the financing activities section as “Proceeds from bank loan—$60,000.” He will report the note instead as “Increase in payables—$60,000” and treat it as an adjustment to net income in the operating activities section. He returns to the president, saying, “You can tell the board to declare their usual dividend. Our net cash flow provided by operating activities is $1,030,000.” “Good man, Kurt! I knew I could count on you,” exults the president.

Instructions

 

Who are the stakeholders in this situation?

Was there anything unethical about the president’s actions? Was there anything unethical about the controller’s actions?

Are the board members or anyone else likely to discover the misclassification?

Sample Solution

Stakeholders in the situation:

  • The stockholders: The stockholders are the ones who ultimately benefit from the dividend payments. They have a right to expect that the company is being managed in a responsible and ethical manner.
  • The board of directors: The board of directors is responsible for overseeing the management of the company. They have a duty to ensure that the company is complying with all applicable laws and regulations.
  • The controller: The controller is responsible for preparing the financial statements of the company. They have a duty to present the financial information accurately and fairly.
  • The president: The president is responsible for the overall management of the company. They have a duty to act in the best interests of the company and its stakeholders.

Was there anything unethical about the president’s actions?

Yes, there was something unethical about the president’s actions. He pressured the controller to misclassify the proceeds from the note payable in order to meet the $1 million threshold for the dividend payment. This is a form of earnings management, which is the practice of manipulating the financial statements to make the company look more profitable than it actually is. Earnings management is unethical because it misleads investors and other stakeholders about the true financial health of the company.

Was there anything unethical about the controller’s actions?

Yes, there was something unethical about the controller’s actions. He agreed to misclassify the proceeds from the note payable in order to meet the $1 million threshold for the dividend payment. This is a form of accounting fraud, which is a serious violation of the public trust. Accounting fraud can have a number of negative consequences, including:

  • It can mislead investors and other stakeholders about the true financial health of the company.
  • It can lead to financial losses for investors and other stakeholders.
  • It can damage the reputation of the company and its management.

Are the board members or anyone else likely to discover the misclassification?

It is possible that the board members or someone else might discover the misclassification. The misclassification would likely show up as an unexplained increase in payables on the balance sheet. If the board members or someone else were to investigate this increase, they would likely discover the misclassification.

In addition, the misclassification could also be discovered by an independent auditor who is auditing the company’s financial statements. Independent auditors are required to perform a number of tests to ensure that the financial statements are accurate and fairly presented. If the independent auditor were to perform these tests, they would likely discover the misclassification.

If the misclassification is discovered, the president and controller could face a number of consequences. They could be fired from their jobs. They could be sued by the company or its shareholders. They could also be prosecuted for accounting fraud.

Conclusion:

The situation described in the prompt is a serious ethical dilemma. The president and controller both engaged in unethical behavior in order to meet the $1 million threshold for the dividend payment. This behavior could have a number of negative consequences, including misleading investors and other stakeholders, leading to financial losses, and damaging the reputation of the company and its management. If the misclassification is discovered, the president and controller could face a number of consequences, including being fired, being sued, and being prosecuted.

This question has been answered.

Get Answer