What should the Controller do?AbstractThe protagonist in this case was recently hired by a non-profit organization that provides neededhealth care services

What should the Controller do?AbstractThe protagonist in this case was recently hired by a non-profit organization that provides neededhealth care services. They are in the midst of a financial crisis which may only be temporary. Heis asked to alter the accounting records for a short period of time to avoid bankruptcy. Thesituation presented in the case is intended to get students to think about the ethical trade-offs inan environment where the “greater good” may actually be achieved by complying with theCFO’s request to alter the records since the health, and even the lives, of some clients may be atrisk if the organization were to fail. This case was designed specifically to encourage students toconsult the AICPA Code of Conduct and the IMA Statement of Ethical Professional Practice andintegrate these standards into their analysis of the case. The Context Tim Brighton is marriedwith two children, ages 3 and 5. His wife was recently laid off from a large national bank. At thistime her job prospects look bleak since her career was oriented toward the financial servicesindustry which has been negatively impacted by the current recession. Tim is a licensed CPAwho recently accepted a position as the controller of Pacific Health Care, a medium sized nonprofit organization specializing in providing healthcare services to low income residents. Untilrecently, Tim was working for a large regional CPA firm where he had a variety of audit clientsincluding non-profit organizations. Tim was tired of the long hours and the pressure of publicaccounting and believed that working in the non-profit sector would be relatively free of stressand that the hours would be more predictable. When he accepted the position of controller atPacific Health Care Tim received an increase in compensation. Since he came to work forPacific, Tim has heard that the prior controller was terminated and that it was a messytermination and that a wrongful termination lawsuit is pending. Pacific derives about eightypercent of its revenue from contracts with the city and the state. The remaining twenty percentcomes from institutional and individual giving. Pacific has a great reputation in the communitybecause of the high quality of the services they provide. The current recession has materiallydiminished the sources of funding available to both state and local governments. Consequently,contracts between Pacific and the municipalities that were once “automatic renewals” havebecome less certain. Contracts that are renewed often times have provisions reducing thereimbursed amounts for service units (health care services provided to clients). The nonrenewalof some contracts and the lower reimbursement amounts on new contracts is beginning to reduceworking capital to dangerously low levels. Pacific has a line of credit with a regional bank in theamount of $500,000. The current economic circumstances have resulted in Pacific needing toutilize the entire $500,000 line of credit with little hope of being able to pay down the debt in thenext year. Pacific is using the line of credit as a source of permanent financing and Tim realizesthat if the line is not renewed an immediate liquidity crisis would result. The bank requires thatthe line be reviewed twice yearly which entails providing them with the most recent financialstatements. The six month review is next week. Tim reports to the CFO of Pacific, AmandaMathews. Tim has quickly learned that Amanda is a hard driving, focused executive and hasaspirations to become the CEO sometime in the future. She tolerates no dissention and viewsdiscussing issues as a waste of time because of her certainty of being correct.Ms. Mathews is concerned that the current financial statements will not be satisfactory to thebank. The statements reflect a fast deterioration of working capital approaching a 1:1 ratio withcurrent liabilities needing to be paid in the next thirty days but amounts due from city and stateagencies expected to be received in the next 60-120 days. The operating statement is currentlyshowing an operating loss. Ms. Mathews is concerned that the statements could cause the bank toincrease the interest rate on the line of credit or cause the line of credit to be cancelled. Thecancellation of the line of credit would bring on such a liquidity crisis that it is doubtful thatPacific could remain a going concern. The CFO has approached Tim to discuss the currentfinancial situation and current financial statements. She indicates to Tim that she believes thatcertain modifications could be made to the statements which would show Pacific in a morefavorable financial and operating position. She tells Tim that it is almost certain that Pacific willreceive a $750,000 grant in the next 4-5 months from a national health care organization. Ms.Mathews believes that this will eliminate the organization’s liquidity problem. Tim knows that heand the CFO must sign a cover letter accompanying the financial statements going to the bank.The letter, in essence, states that the accompanying financial statements, to the best of theirknowledge and belief, present fairly Pacific’s financial position and the operating results inaccordance with generally accepted accounting principles. Tim questions the CFO about theimplication of “modifying the statements” and signing such a letter. She emphatically states thatthis type of “earnings management” is very common in both the profit and non-profit sectors ofthe economy. When survival of an entity is at stake such financial statement modification is theonly thing an entity can do. “After all, where is your loyalty, to the bank or to our clients whodepend on the healthcare services we provide? Any adjustments you make to the books will bereversed once we receive the $750,000 grant and no one will know about the “modified”financial statements but you and me. Also, our audit is over six months away.” Tim knows thedire consequences of his telling the CFO he will not modify the financial statements or sign aletter accompanying the financial statements. Tim decides to postpone consideration of the longterm structural cost issues and he begins to think about how he could modify the accrual basedfinancial statements. His ideas are beginning to evolve: 1. Accrue revenues not yet due from thecity and state. His rationalization is these items are under a contract and they will be due oncePacific provides the services. 2. Exclude certain accrued expenses using the rationalization thatthese items do not need to be paid at this time. 3. Reclassify certain noncurrent assets as currentand classify certain current liabilities as noncurrent. Tim believes that many times suchclassification is somewhat subjective and he is merely using his judgment. Tim is pleased withhis ideas because these modifications will improve both the working capital picture as well asimprove the operating results of Pacific. Yet, he is troubled that he has been asked by the CFO tochange the financial statements so that Pacific looks favorable to the bank. He is equallyconcerned that he will need to provide his signature to the letter accompanying the statements.Tim decides to leave the office and head home to discuss these issues with his wife Maria. Timand Maria prepare the children’s dinner and ready them for bed. Once Maria and Tim have timealone Tim describes the events of his day. He describes the conversation withAmanda. He outlines Pacific’s financial problems and the liquidity and going concern crisis thatwill be faced if the bank does not renew the line of credit. He tells Maria that he must modify thestatements in order for the organization to have a reasonable chance of a renewed credit line. Hediscusses his professional and ethical responsibilities to the profession as well as hisresponsibility to the general public. He asks for Maria’s perspective on the dilemma he faces.Maria does not hesitate to offer her opinion. “Shouldn’t you consider the clients of Pacific first?Many of those people would receive no health care without Pacific and some of them could evendie. It seems to me that t
emporarily adjusting the financial statements is a small price to pay tokeep the services of Pacific available to your clients. Face it Tim, professional ethics alwayssounds somewhat attractive in the classroom but what about the real world?” After a pause,Maria continues. “I think that you also have to consider your family. You know, if you refuse tochange the financial statements Amanda will probably fire you immediately and Pacific will notpay severance. Where will you find a job? We have had a hard time financially since I have beenout of work. How would we manage if you lost your job? Are you prepared to risk your family’swell-being?” Tim ponders the events of the day. “Ethical issues are much more difficult in realitythan in the classroom-I never dreamed I would be placed in such a difficult positionQuestions for Discussion1. Students should consult the Institute of Managerial Accountants (IMA)Statement of Ethical Professional Practice and the American Institute of CertifiedPublic Accountants (AICPA) Code of Professional Conduct. Is Tim still bound bythe AICPA code even though he is no longer working in public accounting? Whichsections of the IMA statement apply to this case? Pacific may or may not haveestablished policies on resolving an ethical conflict.2. Does anyone benefit personally if Amanda’s request is met? Does this matter?3. In considering the broad ethical issues, who is harmed by Amanda’s plan?4. Does it matter that this organization would both be in a better position to provideservices to clients with Amanda’s plan?5. What should Tim do? What are his obligations to Pacific? To Pacific’s clients?To the accounting profession