Question: Listum & Sellum Inc. is a medium-sized
Listum & Sellum Inc. is a medium-sized midwestern real estate company. It was founded five years ago by its two principal stockholders, Willie Listum and Dewey Sellum. Willie is president of the company, and Dewey is vice president of sales. Listum & Sellum has enjoyed tremendous growth since its inception by aggressively seeking out listings for residential real estate and paying a generous commission to the selling agent.
The company receives a 6% commission for selling a client’s property and gives two-thirds of this, or 4% of the selling price, to the selling agent. For example, if a house sells for $100,000, Listum & Sellum receives $6,000 and pays $4,000 of this to the selling agent. At the time of the sale, the company records increases in Accounts Receivable and Sales Revenue of $6,000 each. The accounts receivable is normally collected within 30 days. Also at the time of sale, the company records increases in Commissions Expense and Commissions Payable of $4,000 each. Sales agents are paid by the 15th of the month following the month of the sale. In addition to the commissions expense, Listum & Sellum’s other two major expenses are advertising of listings in local newspapers and depreciation of the company’s fleet of Cadillacs. (Dewey believes that all of the sales agents should drive Cadillacs.) The newspaper ads will run for one month, and the company has until the 10th of the following month to pay that month’s bill. The automobiles are depreciated over four years. (Dewey doesn’t believe that any salesperson should drive a car that is more than four years old.)
Due to a downturn in the economy in the Midwest, sales have been sluggish for the first 11 months of the current year, which ends on June 30. Willie is very disturbed by the slow sales this particular year because a large note payable to the local bank is due in July and the company plans to ask the bank to renew the note for another three years. Dewey seems less concerned by the unfortunate timing of the recession and has some suggestions as to how he and Willie can ‘‘paint the rosiest possible picture for the banker’’ when they go for the loan extension in July. In fact, Dewey has some very specific recommendations for you as to how to account for transactions during June, the last month in the fiscal year.
You are the controller for Listum & Sellum and have been treated very well by Willie and Dewey since joining the company two years ago. In fact, Dewey insists that you drive the top-of the- line Cadillac. Following are his suggestions:
First, for any sales made in June, we can record the 6% commission revenue immediately but delay recording the 4% commission expense until July, when the sales agent is paid. We record the sales at the same time we always have, the sales agents get paid when they always have, the bank sees how profitable we have been, we get our loan, and everybody is happy!
Second, since we won’t be paying our advertising bills for the month of June until July 10, we can wait until then to record the expense. The timing seems perfect since we are meeting with the bank for the loan extension on July 8.
Third, since we will be depreciating the fleet of ‘‘Caddys’’ for the year ending June 30, how about changing the estimated useful life on them to eight years instead of four years? We won’t say anything to the sales agents; no need to rile them up about having to drive their cars for eight years. Anyhow, the change to eight years would just be for accounting purposes. In fact, we could even switch back to four years for accounting purposes next year. Likewise, the changes in recognizing commission expense and advertising expense don’t need to be permanent either; these are just slight bookkeeping changes to help us get over the hump!
Required:
Use the Ethical Decision Framework in Exhibit 1-9 to complete the following requirements:
Exhibit 1-9:
1. Recognize an ethical dilemma: Explain why each of the three proposed changes in accounting will result in an increase in net income for the year ending June 30. Identify any concerns you have with each of these proposed changes in accounting from the perspective of GAAP. What ethical dilemma(s) do you now face?
2. Analyze the key elements in the situation:
a. Who may benefit or be harmed?
b. How are they likely to benefit or be harmed?
c. What rights or claims may be violated?
d. What specific interests are in conflict?
e. What are your responsibilities and obligations?
3. List alternatives and evaluate the impact of each on those affected: As the controller, what are your options in dealing with the ethical dilemma(s) you identified in (1) above? Which provides the other investors and the bank with information that is most relevant, most complete, most neutral, and most free from error?
4. Select the best alternative: Among the alternatives, which one would you select? Explain your decision in the form of a memo written to the two owners.
Transcribed Image Text:
Times when an ethical dilemma is likely to occur are when a company is considering a decision about accounting methods or disclosures and when one of the following takes place: • There are conflicting accounting rules. There are no GAAP to follow. Fraud or other questionable actions have occurred. Identification 1. Recognize an ethical dilemma. Examples of: Those who may benefit or be harmed management, shareholders, potential investors, the auditor, creditors, employees. Benefits higher pay. promotion, increased status in the community. HarmHoss of job, bankruptcy, customer's failure to pay debt. Rights/claims-payments to creditors, obligations to customers. Conflicting interests-a member of the board of directors who is also a company employee, a manager whose bonus is based on sales. Responsibilities-providing the most accurate information, reporting fraud. Analysis 2. Analyze the key elements in the situation. Among the alternatives, which provides: The most useful and timely information to decision makers? The most faithful representation to decision makers? Information that most accurately represents what it claims to report? Information that is free from bias toward any certain result? 3. List alternatives and evaluate the impact of each on those affected. What is the likely impact of each alternative on those affected? Resolution Among the alternatives, which provides decision makers with information that is the most relevant, most complete, most neutral, and most free from error? 4. Select the best alternative.
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