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Bank of Gould Case Study

18 March 2007

Rico Pena and Hayden Foote had a conversation that included discussion of what may turn out to be questionable accounting practices.  This conversation took place over speaker phone while Elizabeth Gutierrez was sitting in Rico’s office.  Mr.  Foote possibly did not know that Elizabeth was in the room with Rico or that they were on speaker. Rico has compromised Mr.  Foote, as well as Elizabeth and himself.

Did Yung and Broebeck, LLP and Rico Pena help Hayden Foote and Sensor Circuits to commit fraud by issuing unqualified financial statements?  Did Hayden Foote and Sensor Circuits willingly and knowingly defraud the Bank of Gould? Elizabeth now faces the greatest of ethical dilemmas – should she report this transaction to Rico’s senior managers at the firm.

Issues in this case

By Rico issuing an unqualified opinion to Sensor Circuits he is stating that the $2.9 million gain recorded on paper is an accurate picture of Sensor’s financial situation.  As a banker, I would look at that transaction and assume this gain has been realized even if the cash is gone.  With the $2.9 million plus depreciation added back in, what the bank saw was an inaccurate picture of Sensor’s cash flow.  The red

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flags in this case are Sensor’s ability to earn substantial profits during a time of industry-wide losses, and Rico’s statement that without the loan proceeds Sensor’s financial situation appears bleak.

Given that Elizabeth did some field work on Sensor’s financial statements, combined with over hearing this conversation, she is justified to further question the transactions.  In my opinion she is obligated at this point, as she may be implicated in fraud.

Sensor buys and sells stock investments and posts the gains as income.  In the case of Greenco, the gains were only on paper, and would not be realized for 5 years.  There is obviously no operating cash flow from this transaction.  If Sensor does this on a regular basis, then the auditor should be advising them on the accounting principles relating to reporting the gains and the asset value of such transactions.

Analyzing the ethics

To determine if their actions are ethical and justified, we will apply th AICPA Code of Professional Conduct to Rico Pena and Elizabeth Gutierrez, and GAAP rules on revenue recognition and value of notes to Hayden Foote.  The AICPA Code of Professional Conduct, Section 50 Principles of Professional Conduct (ET Section 53 – Article II—The Public Interest ) reads as follows:

ET Section 53 – Article II—The Public Interest

Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate commitment to professionalism.

A distinguishing mark of a profession is acceptance of its responsibility to the public. The accounting profession’s public consists of clients, credit grantors, governments, employers, investors, the business and financial community, and others who rely on the objectivity and integrity of certified public accountants to maintain the orderly functioning of commerce. This reliance imposes a public interest responsibility on certified public accountants. The public interest is defined as the collective well-being of the community of people and institutions the profession serves.

In discharging their professional responsibilities, members may encounter conflicting pressures from among each of those groups. In resolving those conflicts, members should act with integrity, guided by the precept that when members fulfill their responsibility to the public, clients’ and employers’ interests are best served.

Section 53.01

Rico did not exercise his responsibility to Sensor Circuits or to the Bank of Gould.  Under this section, Bank of Gould granted a loan based on what they believed to be an objective audit done with integrity.  However, the well being of the bank is at stake.  Since the gains from the stock sale are five years from realization, if Sensor defaults, the bank may be unable to collect. If the note is collateral, the value of the note has been misrepresented.  Elizabeth exercised part of her responsibility under this section by questioning the details of the Sensor-Bank of Gould transaction with Rico.

Section 53.02

Elizabeth is encountering conflicting pressure from Rico in this case.  At this point she is faced with the dilemma of whether to let this information go without further involvement, or to go to Rico’s managing supervisor.  It would be both ethical and justifiable for Elizabeth to take this situation further.  She is in a position to protect the interest of the public (Bank of Gould), the client Sensor Circuits, and of her employer Yung and Broebeck.

GAAP principles of revenue recognition

Revenue is generally realized when it is earned.  Revenue from an asset is considered to be realizable when the asset can be converted to cash or a claim for cash as in the note with Greenco.  The ethical dilemma for Rico as auditor is to determine if the revenue from the Greenco not is realizable at the time the financial statements were created and audited.  As CFO, Hayden Foote should be familiar with these reporting principles.

It appears as if Sensor Circuits has made it an internal practice to engage in stock trading practices and then record immediate gains that do not pass the realizability test.  That being the case, Sensor has not only violated basic accounting ethics, but has defrauded the Bank of Gould, as well as Sensor’s shareholders and clients.

GAAP principles of valuing receivables

Elizabeth was justified to question the valuation of the Greenco note based on her knowledge that receivables due in more than 12 months should be carried at present value.  Rico was justified to consider the realizability of the note for revenue recognition.  However, as Rico stated “Sensor won’t see the cash for five years”, he should not have issued the unqualified opinion on Sensor’s statements showing an inaccurate asset valuation and cash flow position.

Conclusion

Hayden Foote, as CFO os Sensor Circuits was responsible for correct internal accounting practices.  What appears to have happened is that Sensor may have been operating at near losses over the four year period in question.  Sensor must have attempted to solve the problem on paper with the incorrect accounting for their frequent stock transactions.  Hayden Foote allowed fraudulent accounting practices to position Sensor as the only company realizing high profits in an industry that is otherwise operating at substantial losses.

Rico Pena, as an auditing manager and CPA, violated nearly every ethics test that can be applied to any business.  He breached the confidentiality of Sensor and Mr.  Foote.  He is fully aware of the details of all of Sensor’s transactions and internal practices, yet he failed to issue a qualified opinion on financial statements.  He has assisted Sensor in obtaining a fraudulent bank loan.  Finally, he has compromised his colleague, Elizabeth, and his employer.  Not only are Rico’s actions unethical and unjustifiable, but possibly illegal.

Elizabeth Gutierrez took the most ethical and justifiable position in the case by obtaining as much detail as possible about the case.  However, the case details leaves Elizabeth’s ethics hanging in the balance.  What did she do with this information?  She should continue the dialogue with Rico as her colleague and superior.  She also needs to take a second look at other projects she is working on as part of Rico’s audit team.  Based on what she determines, Elizabeth should go to Rico’s superiors for further investigation.  Elizabeth is in a unique position to protect Yung and Brobeck from potential legal issues that may result if Sensor Circuits defaults on the Bank of Gould loan.

Works Cited

“AICPA Code of Professional Conduct, ET Section 53 – Article II—The Public Interest.” American Institute of Certified Public Accountants. 16 Mar. 2008. <https://www.aicpa.org/about/code/et_s ection_53__article_ii_the_public_intere st.html>.

“Financial Accounting Standards Board (FASB), Statements of Financial Accounting Standards (SFAS)” Generally Accepted Accounting Principles in the United States. 16 Mar. 2008. <http://cpaclass.com/gaap/sfas/gaap-sf as-01.htm>.

“Revenue Recognition Principle.” Accounting Study Guide Financial Statements Overview. 16 Mar. 2008. <http://accountinginfo.com/study/fs/re venue-101.htm>.

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