âBabbit Corp. is a medium sized wholesaler of automotive parts.It has ten stockholders who have been paid a total of $1 million incash dividends for 8 consecutive years. That boardâs policyrequires that, for this dividend to be declared, net cash providedby operating activities as reported in Babbitâs current yearâsstatement of cash flows must exceed $1 million. President and CEOMilton Williamsâs job is secure so long as he produces annualoperating cash flows to support the usual dividend.
At the end of the current year, controller Jerry Roberts presentspresident Milton Williams with some disappointing news: The netcash provided by operating activities is calculated by the indirectmethod to be only $970,000. The president says to Jerry, "We mustget amount above $1 million. Isnât there some way to increaseoperating cash flow by another $30,000?" Jerry answers, "Thesefigures were prepared by my assistant. Iâll go back to my officeand see what I can do." The president replies, "I know you wonâtlet me down, Jerry."
Upon close scrutiny of the statement of cash flows, Jerry concludesthat he can get the operating cash flows above $1 million byreclassifying a $60,000, 2-year note payable listed in thefinancing activities section as "Proceeds from bank loan -$60,000." He will report the note instead as "Increase inpayables-$60,000" and treat it as an adjustment of net income inthe 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, Jerry! I knew I could count on you," exults thepresident.
Address the following questions:
Who are the stakeholders in this situation?
Was there anything unethical about the presidentâs actions? Wasthere anything unethical about the controllerâs actions?
Are the board members or anyone else likely to discover themisclassification?â
âBabbit Corp. is a medium sized wholesaler of automotive parts.It has ten stockholders who have been paid a total of $1 million incash dividends for 8 consecutive years. That boardâs policyrequires that, for this dividend to be declared, net cash providedby operating activities as reported in Babbitâs current yearâsstatement of cash flows must exceed $1 million. President and CEOMilton Williamsâs job is secure so long as he produces annualoperating cash flows to support the usual dividend.
At the end of the current year, controller Jerry Roberts presentspresident Milton Williams with some disappointing news: The netcash provided by operating activities is calculated by the indirectmethod to be only $970,000. The president says to Jerry, "We mustget amount above $1 million. Isnât there some way to increaseoperating cash flow by another $30,000?" Jerry answers, "Thesefigures were prepared by my assistant. Iâll go back to my officeand see what I can do." The president replies, "I know you wonâtlet me down, Jerry."
Upon close scrutiny of the statement of cash flows, Jerry concludesthat he can get the operating cash flows above $1 million byreclassifying a $60,000, 2-year note payable listed in thefinancing activities section as "Proceeds from bank loan -$60,000." He will report the note instead as "Increase inpayables-$60,000" and treat it as an adjustment of net income inthe 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, Jerry! I knew I could count on you," exults thepresident.
Address the following questions:
Who are the stakeholders in this situation?
Was there anything unethical about the presidentâs actions? Wasthere anything unethical about the controllerâs actions?
Are the board members or anyone else likely to discover themisclassification?â
