Hi There,
New to the forums, I am helping a friend out with accounting, and I have little accounting background, and was wondering for some insight on the following Ethical problem:
"Ethical Issue:
In the fall of 2006, encouraged by enthusiasm from american retailers, we launched COLD-FX in the US. In the face of unexpectadly high return rates from U.S. retailers, we announced on April 11, 2007 that we would restate our financial results, due to a reconsideration of the way we apply our revenue recognition policy. As a result of our announcement, Securities Commissions in Alberta, B.C. and Ontario issued interim trading halts on our shares. After restated financials were released, trading in the shares resumed on July 11, 2007."
The questions on this case are listed below in BOLD, while my thoughts/answers are listed after:
Having read over the questions, I’ll try to explain exactly what’s going on.
The company CV technology launched a new product, COLD-FX in 2006. Once the product had been to market for a while, the rate of returns (how many were sold, and how much revenue was recorded) was unreasonably high. This was due to the fact that the way in which CV technology recognized revenue was flawed in some way (question doesn’t say how or why) In other words they weren’t keeping accurate accounting records.
So on April 11, 2007, CV technology announced that they would be restating their financial results (meaning they would go back and take a look at why they were making a mistake in how they were recording their revenue, and eventually come back and make public their ACTUAL revenue)
But since it takes time for CV technology to figure out exactly where they were messing up, different Security Commissions in Canada decided they were not going to be trading CV technology shares until their revenue figures were sorted out, which makes sense since it’s impossible to know exactly where the company stands in profitability.
So onto the questions:
1) Why is it important that this type of information be disclosed?
I’m not sure if you have learned about this yet, but in accounting there is something called "GAAP" accounting principles. These are basically like the "10 commandments" of accounting, just basic rules and guidelines to follow in order to meet ethical and practical accounting standards.
One of the GAAP principles is called the principle of prudence:
"This principle aims at showing the reality "as is": one should not try to make things look prettier than they are. Typically, revenue should be recorded only when it is certain..."
And there’s also the principle of disclosure/materiality:
All information and values pertaining to the financial position of a business must be disclosed in the records.
These are just saying how it’s important to make sure revenue statements are accurate, and how you must make sure they are accurate. And with CV Technology, they weren’t initially accurately reporting their revenue.
2) Suppose you are the CFO, what ethical issues would you face as you consider what to report in the 2007 annual report?
Well if you chose to report the incorrect revenues (the ones which skewed the numbers to make it look like your revenues were actually higher than they were) you would be ethically responsible for anything that happens (positive or negative) that happens as a result. People would think that revenue was higher than it actually was, so they might invest because you painted a pretty picture, and then lose a bunch of money when the stock shares eventually go down due to lessened consumer confidence when the truth comes out.
3) Negative consequences of CV technology not telling the truth:
Well the truth should eventually come out in the numbers, and the backlash they receive from that from a financial and consumer/investor perspective might be worse than if they had just been honest in the first place (People won’t typically invest in a company with a bad accounting reputation)
Negative consequences of telling the truth:
Well their revenue for COLD-FX is undoubtedly lower than what they initially reported, so this would lower the perceived relative company/product value in the eyes of consumers/investors, this probably means there will be less sales a well as less investor money coming in had they just done nothing and kept the old revenue figures public and unchanged.
I am wondering if I am on the right track or if there is anything that I should add...
thanks for your input!
New to the forums, I am helping a friend out with accounting, and I have little accounting background, and was wondering for some insight on the following Ethical problem:
"Ethical Issue:
In the fall of 2006, encouraged by enthusiasm from american retailers, we launched COLD-FX in the US. In the face of unexpectadly high return rates from U.S. retailers, we announced on April 11, 2007 that we would restate our financial results, due to a reconsideration of the way we apply our revenue recognition policy. As a result of our announcement, Securities Commissions in Alberta, B.C. and Ontario issued interim trading halts on our shares. After restated financials were released, trading in the shares resumed on July 11, 2007."
The questions on this case are listed below in BOLD, while my thoughts/answers are listed after:
Having read over the questions, I’ll try to explain exactly what’s going on.
The company CV technology launched a new product, COLD-FX in 2006. Once the product had been to market for a while, the rate of returns (how many were sold, and how much revenue was recorded) was unreasonably high. This was due to the fact that the way in which CV technology recognized revenue was flawed in some way (question doesn’t say how or why) In other words they weren’t keeping accurate accounting records.
So on April 11, 2007, CV technology announced that they would be restating their financial results (meaning they would go back and take a look at why they were making a mistake in how they were recording their revenue, and eventually come back and make public their ACTUAL revenue)
But since it takes time for CV technology to figure out exactly where they were messing up, different Security Commissions in Canada decided they were not going to be trading CV technology shares until their revenue figures were sorted out, which makes sense since it’s impossible to know exactly where the company stands in profitability.
So onto the questions:
1) Why is it important that this type of information be disclosed?
I’m not sure if you have learned about this yet, but in accounting there is something called "GAAP" accounting principles. These are basically like the "10 commandments" of accounting, just basic rules and guidelines to follow in order to meet ethical and practical accounting standards.
One of the GAAP principles is called the principle of prudence:
"This principle aims at showing the reality "as is": one should not try to make things look prettier than they are. Typically, revenue should be recorded only when it is certain..."
And there’s also the principle of disclosure/materiality:
All information and values pertaining to the financial position of a business must be disclosed in the records.
These are just saying how it’s important to make sure revenue statements are accurate, and how you must make sure they are accurate. And with CV Technology, they weren’t initially accurately reporting their revenue.
2) Suppose you are the CFO, what ethical issues would you face as you consider what to report in the 2007 annual report?
Well if you chose to report the incorrect revenues (the ones which skewed the numbers to make it look like your revenues were actually higher than they were) you would be ethically responsible for anything that happens (positive or negative) that happens as a result. People would think that revenue was higher than it actually was, so they might invest because you painted a pretty picture, and then lose a bunch of money when the stock shares eventually go down due to lessened consumer confidence when the truth comes out.
3) Negative consequences of CV technology not telling the truth:
Well the truth should eventually come out in the numbers, and the backlash they receive from that from a financial and consumer/investor perspective might be worse than if they had just been honest in the first place (People won’t typically invest in a company with a bad accounting reputation)
Negative consequences of telling the truth:
Well their revenue for COLD-FX is undoubtedly lower than what they initially reported, so this would lower the perceived relative company/product value in the eyes of consumers/investors, this probably means there will be less sales a well as less investor money coming in had they just done nothing and kept the old revenue figures public and unchanged.
I am wondering if I am on the right track or if there is anything that I should add...
thanks for your input!