High School

**Scenario:**

It’s no fun accepting a position for your dream job and then encountering red flags that make you question the company culture. Such are the thoughts of Donna Mason on January 18, 2022, as she prepares for a meeting with her accounting supervisor, Cheryl Miles. Mason graduated summa cum laude from State University one year ago and recently passed the CPA Exam. She is working as a staff accountant at Harrison Industries in Provo, Utah. Mason is one of three staff accountants reporting to Cheryl Miles, who reports to Kelly Lang, the chief accounting officer. Lang reports to the CEO, Ken Harrison, the third generation of owner-CEOs of the privately held company. Harrison also serves as the chair of the board of directors, which includes five out of nine independent members.

Mason’s concern arose when, on January 15, 2022, Miles instructed her to record an accrual for unpaid severance payments of $5 million for inclusion in the December 31, 2021, financial statements. When Mason questioned this, Miles explained that the company had exceeded projected earnings in 2021 but anticipated a downturn in 2022. Mason found this amount unusually high. Miles then justified the accrual by stating that the company planned to shut down the home appliance division in 2022, resulting in significant severance payments. This was the first Mason heard about any division shutdown, which she found odd since the company’s operating income across all divisions had set record levels in fiscal year 2021. Furthermore, the severance amount was five times the annual payroll of the division.

The operating income levels and accruals from 2019 through 2021 are as follows:

- **12/31/2019**
- Operating Income: $10 million
- Accrued Bonus and Severance: $1 million

- **12/31/2020**
- Operating Income: $12 million
- Accrued Bonus and Severance: $1.2 million

- **12/31/2021**
- Operating Income: $20 million (pre-adjusting entries)
- Accrued Bonus and Severance: ???

Initially, Mason took a firm stance, asking Miles for documentation to record the accrued severance liability. Miles instructed Mason to record the entry, asserting that it wasn’t her role to question orders and that questioning directions from one’s supervisor was grounds for termination. This conversation took place on January 15, 2022. Mason knew she had three days before her next meeting with Miles to consider her options. She reached out to her mentor, Steve Hahn, who explained that the company culture favored compliance. Hahn noted it was rare for employees to be asked to comply with questionable actions, advising Mason to follow Miles's instructions. He implied that if Miles asked her to record the severance payments, there must be justification.

Between January 15 and January 18, 2022, Mason conducted independent checks of the company’s computer files and found no evidence of a planned division shutdown. In fact, the division’s income had increased by an average of 5 percent per year for three consecutive years. The income level for 2021 was the highest, increasing by 8 percent and exceeding projections by 3 percent.

Mason is devising a strategy to convince Miles that the severance accrual is not justified. She considers whether Miles might be acting under orders from Kelly Lang and/or Ken Harrison and wonders if she should approach them about her concerns. After all, they interviewed her for the accounting position and ultimately offered her the job. Initially, Mason felt positive about working for Harrison Industries because she believed in their organizational values and ethics, which align with her own. Now, she’s uncertain.

**Questions:**

1. Discuss how the accrual of these expenses might be used to manage earnings.

2. What is at stake for the key parties? What are Mason’s ethical obligations to them?

3. Explain the rationalizations given by Miles to Mason and how they should affect Mason's handling of the matter.

4. What should Mason do and why?

Answer :

The accrual of these expenses could potentially be used to manage earnings. The key parties involved in this situation are Donna Mason, Cheryl Miles, Kelly Lang, Ken Harrison, and the company itself.

1. The accrual of these expenses could potentially be used to manage earnings. By recording a significant accrual for unpaid severance payments, the company can decrease its reported income for the current period, thereby improving its financial performance and meeting or exceeding projected earnings targets. This practice, known as earnings management, allows companies to manipulate their financial statements to present a more favorable picture to investors, lenders, or other stakeholders. However, if the accrual is not supported by actual events or is inflated beyond what is reasonable, it can be considered unethical and misleading.

2. The key parties involved in this situation are Donna Mason, Cheryl Miles, Kelly Lang, Ken Harrison, and the company itself. Mason's ethical obligations are to act in the best interest of the company and its stakeholders by ensuring the accuracy and integrity of the financial statements. She also must follow professional ethics and standards as a certified public accountant (CPA). At stake is the company's reputation, financial stability, and compliance with legal and ethical requirements. Mason needs to consider the potential consequences of her actions on her career and professional standing.

3. Miles provided rationalizations for the accrual, such as the company's exceeded projected earnings and the planned shutdown of the home appliance division. However, Mason's independent investigation revealed no evidence of a planned shutdown, and the division's income had consistently increased in recent years. These rationalizations should raise red flags for Mason and indicate that the accrual may not be justified. Mason should not simply accept Miles' explanations without proper evidence or documentation to support the accrual.

4. Mason should act ethically and responsibly by addressing her concerns through appropriate channels. She should consider discussing the issue with her mentor, Steve Hahn, who can provide guidance and support. If Mason still has doubts after consulting with Hahn, she should consider approaching higher-level authorities, such as Kelly Lang or Ken Harrison, to express her concerns and seek clarification. Mason needs to present her findings and evidence professionally and respectfully, highlighting her commitment to integrity and accurate financial reporting. Ultimately, Mason must make a decision based on her professional judgment and ethical principles, keeping in mind the potential impact on her career and the company's reputation.

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