Chapter Review
11-7jCases & Projects
Ethics In Action
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Tonya Latirno is a staff accountant for Cannally and Kennedy, a local CPA firm. For the past 10 years, the firm has given employees a year-end bonus equal to two weeks’ salary. On November 15, the firm’s management team announced that there would be no annual bonus this year. Because of the firm’s long history of giving a year-end bonus, Tonya and her coworkers had come to expect the bonus and believed that Cannally and Kennedy had breached an implicit agreement by discontinuing the bonus. As a result, Tonya decided that she would make up for the lost bonus by working an extra six hours of overtime per week for the rest of the year. Cannally and Kennedy’s policy is to pay overtime at 150% of straight time.
Tonya’s supervisor was surprised to see overtime being reported, because there is generally very little additional or unusual client service demands at the end of the calendar year. However, the overtime was not questioned, because employees are on the “honor system” in reporting their work hours.
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Is Cannally and Kennedy acting in an ethical manner by eliminating the bonus? Explain your answer.
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Is Tonya behaving ethically by making up the bonus with unnecessary overtime? Why or why not?
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Ethics In Action
Marvin Turner was discussing summer employment with Tina Song, president of Motown Construction Service:
I’m glad you’re thinking about joining us for the summer. We certainly can use the help.
Sounds good. I enjoy outdoor work, and I could use the money to help with next year’s school expenses.
I’ve got a plan that can help you out on that. As you know, I’ll pay you $14 per hour, but in addition, I’d like to pay you with cash. Since you’re only working for the summer, it really doesn’t make sense for me to go to the trouble of formally putting you on our payroll system. In fact, I do some jobs for my clients on a strictly cash basis, so it would be easy just to pay you that way.
Well, that’s a bit unusual, but I guess money is money.
Yeah, not only that, it’s tax-free!
What do you mean?
Didn’t you know? Any money that you receive in cash is not reported to the IRS on a W-2 form; therefore, the IRS doesn’t know about the income—hence, it’s the same as tax-free earnings.
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Why does Tina Song want to conduct business transactions using cash (not check or credit card)?
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How should Marvin respond to Tina’s suggestion?
Team Activity
In teams, select a public company that interests you. Obtain the company’s most recent annual report on Form 10-K. The Form 10-K is a company’s annually required filing with the Securities and Exchange Commission (SEC). It includes the company’s financial statements and accompanying notes. The Form 10-K can be obtained either (a) by referring to the investor relations section of the company’s website or (b) by using the company search feature of the SEC’s EDGAR database service found at www.sec.gov/edgar/searchedgar/companysearch.html.
Based on the information in the company’s most recent annual report, answer the following questions:
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What amount of current liabilities does the company report on its balance sheet at the end of the most recent year? What types of current liabilities does the company report?
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Have current liabilities increased or decreased from the prior year? If so, by what amount?
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Does the company disclose any contingent liabilities in the notes to the financial statements? If so, briefly describe the nature of these contingent liabilities.
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How much of the company’s long-term debt will come due in the coming year?
Payroll Forms
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Payroll accounting involves the use of government-supplied forms to account for payroll taxes. Three common forms are the W-2, Form 940, and Form 941. Form a team with three of your classmates and retrieve copies of each of these forms. They may be obtained from a local IRS office, a library, or the Internet at www.irs.gov (go to forms and publications).
Communication
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WBM Motorworks is a manufacturer of high-end touring and off-road motorcycles. On November 30, the company was sued by a customer who was injured when the front shock absorber on the WBM Series 3 motorcycle cracked during use. The company conducted a preliminary investigation into the matter during December and found evidence of a manufacturing defect in the shock absorber. While it is uncertain whether the manufacturing defect is the source of the product failure, the company has voluntarily recalled the front shock absorbers on the Series 3 motorcycles. The company is uncertain how the lawsuit will be resolved. Similar lawsuits against other manufacturers have been settled for approximately $2,000,000.
Write a brief memo to the president of WBM Motorworks, U. D. Mach III, discussing how the lawsuit might be reported on the financial statements.
Recognizing Pension Expense
The annual examination of Felton Company’s financial statements by its external public accounting firm (auditors) is nearing completion. The following conversation took place between the controller of Felton Company (Francie) and the audit manager from the public accounting firm (Sumana):
You know, Francie, we are about to wrap up our audit for this fiscal year. Yet, there is one item still to be resolved.
What’s that?
Well, as you know, at the beginning of the year, Felton began a defined benefit pension plan. This plan promises your employees an annual payment when they retire, using a formula based on their salaries at retirement and their years of service. I believe that a pension expense should be recognized this year, equal to the amount of pension earned by your employees.
Wait a minute. I think you have it all wrong. The company doesn’t have a pension expense until it actually pays the pension in cash when the employee retires. After all, some of these employees may not reach retirement, and if they don’t, the company doesn’t owe them anything.
You’re not really seeing this the right way. The pension is earned by your employees during their working years. You actually make the payment much later—when they retire. It’s like one long accrual—much like incurring wages in one period and paying them in the next. Thus, I think you should recognize the expense in the period the pension is earned by the employees.
Let me see if I’ve got this straight. I should recognize an expense this period for something that may or may not be paid to the employees in 20 or 30 years, when they finally retire. How am I supposed to determine what the expense is for the current year? The amount of the final retirement depends on many uncertainties: salary levels, employee longevity, mortality rates, and interest earned on investments to fund the pension. I don’t think an amount can be determined even if I accepted your arguments.
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Evaluate Sumana’s position. Is she right, or is Francie correct?
Contingent Liabilities
Philip Morris International Inc. has numerous pages dedicated to describing contingent liabilities in the notes to recent financial statements. These pages include extensive descriptions of multiple contingent liabilities. Use the Internet to research Philip Morris International Inc. at www.pmi.com.
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What are the major business units of Philip Morris International Inc.?
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Based on your understanding of this company, why would Philip Morris International require so many pages of contingency disclosure?