automotive parts. It has ten stockholders, who have been paid a total of $1
million in cash dividends for eight consecutive years. The policy of the Board
of Directors requires that in order for this dividend to be declared, net cash
provided by operating activities as reported in Puebla’s current year’s
statement of cash flows must be in excess of $1 million. President and CEO Phil
Monat’s job is secure so long as he produces annual operating cash flows to
support the usual dividend.
At the end of the current year, controller Rick Rodgers
presents president Monat with some disappointing news: The net cash provided by
operating activities is calculated, by the indirect method, to be only
$970,000. The president says to Rick, “We must get that amount above $1
million. Isn’t there some way to increase operating cash flow by another
$30,000?” Rick answers, “These figures were prepared by my assistant.
I’ll go back to my office and see what I can do.” The president replies,
“I know you won’t let me down, Rick.”
Upon close scrutiny of the statement of cash flows, Rick
concludes that he can get the operating cash flows above $1 million by
reclassifying a $60,000, 2-year note payable listed in the financing activities
section as “Proceeds from bank loan-$60,000.” He will report the note
instead as “Increase in payables-$60,000” and treat it as an
adjustment of net income in the 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, Rick! I knew I could count on you,” exults the president.
Instructions
(a) Who are the stakeholders in this situation?
(b) Was there anything unethical about the president’s
actions? Was there anything unethical about the controller’s actions?
(c) Are the Board members or anyone else likely to discover
the misclassification?
