Reference no: EM131638724

DigitPrint Case Study

DigitPrint was formed in March 2015 with the goal of developing an outsource business for high-speed digital printing. The company is small and does not yet have a board of directors. The comparative advantage of the company is that its founder and president, Henry Higgins, owned his own print shop for several years before starting DigitPrint. Higgins recently hired Liza Doolittle to run the start-up business. Wally Wonderful, who holds the Certified Management Accountant (CMA) certification from the IMA, was hired to help set up a computerized system to track incoming purchase orders, sales invoices, cash receipts, and cash payments for the printing business.

DigitPrint received $2 million as venture capital to start the business. The venture capitalists were given an equity share in return. From the beginning, they were concerned about the inability of the management to bring in customer orders and earn profits. In fact, only $200,000 net income had been recorded during the first year. Unfortunately, Wonderful had just discovered that $1 million of accrued expenses had not been recorded at year-end. Had that amount been recorded, the $200,000 net income of DigitPrint would have changed to an $800,000 loss.

Wonderful approached his supervisor, Doolittle, with what he had uncovered. She told him in no uncertain terms that the $1 million of expenses and liabilities could not be recorded, and warned him of the consequences of pursuing the matter any further. The reason was that the venture capitalists might pull out from financing DigitPrint because of the reduction of net income, working capital, and the higher level of liabilities. Wonderful is uncertain whether to inform Higgins. On one hand, he feels a loyalty obligation to go along with Doolittle. On the other hand, he believes he has an ethical obligation to the venture capitalists and other financiers that might help fund company operations.

We provide a brief analysis of ethical reasoning methods based on the following. First, consider the ethical standards of the IMA and evaluate potential actions for Wonderful. Then, use ethical reasoning with reference to the obligations of an accountant to analyze what you think Wonderful should do.

IMA Standards

Wonderful is obligated by the competence standard to follow relevant laws, regulations, and technical standards, including GAAP, in reporting financial information. Of particular importance is his obligation to disclose all relevant information, including the accrued expenses, that could reasonably be expected to influence an intended user's understanding (i.e., venture capitalists) of the financial reports. Doolittle has refused to support his position and told him in no uncertain terms not to pursue the matter.

 At this point, Wonderful should follow the Resolution of Ethical Conduct procedures outlined in the IMA Standards and take the matter up the chain of command. Typically, in a public corporation, this would mean to go as far as the audit committee of the board of directors. However, DigitPrint is a small company without a board, so Henry Higgins, the founder and president, is the final authority. If Higgins backs Doolittle's position of nondisclosure, then Wonderful should seek outside advice from a trusted adviser, including an attorney, to help evaluate legal obligations and rights concerning the ethical conflict. The danger for Wonderful would be if he goes along with the improper accounting for the accrued expenses, and the venture capitalists find out about the material misstatement in the financial statements at a later date, then Wonderful would be blamed both by the company and the venture capitalists.

Utilitarianism

Wonderful should attempt to identify the harms and benefits of the act of recording the transactions versus not recording them. The consequences of failing to inform the venture capitalists about the accrued expenses are severe, not only for Wonderful but also for DigitPrint. These include a possible lawsuit, investigation by regulators for failing to record the information, and, most important, a loss of reputational capital in the marketplace. The primary benefit to Wonderful is acceptance by his superiors, and he can be secure in the knowledge that he'll keep his job. Utilitarian values are difficult to assign to each potential act. Still, Wonderful should act in accordance with the moral rule that honesty requires not only truth telling, but disclosing all the information that another party has a need (or right) to know.

Rights Theory

The venture capitalists have an ethical right to know about the higher level of payables, the lower income, and the effect of the unrecorded transactions on working capital; the company has a duty to the venture capitalists to record the information. Wonderful should take the necessary steps to support such an outcome. The end goal of securing needed financing should not cloud Wonderful's judgment about the means chosen to accomplish the goal (i.e., nondisclosure). Wonderful should ask whether he believes that others in a similar situation should cover up the existence of $1 million in accrued expenses. Assuming that this is not the case, he shouldn't act in this way.

Justice

In this case, the justice principle is linked to the fairness of the presentation of the financial statements. The omission of the $1 million of unrecorded expenses means that the statements would not "present fairly" financial position and results of operations. It violates the rights of the venture capitalists to receive accurate and reliable financial information. As previously explained, a procedural justice perspective applied to the case means to assess the support for employee decisions on the part of the company. As a new employee, Wonderful needs to understand the corporate culture at DigitPrint.

Virtue Considerations

Wonderful is expected to reason through the ethical dilemma and make a decision that is consistent with virtue considerations. The virtue of integrity requires Wonderful to have the courage to withstand the pressure imposed by Doolittle and not subordinate his judgment to hers. Integrity is the virtue that enables Wonderful to act in this way. While he has a loyalty obligation to his employer, it should not override his obligation to the venture capitalists, who expect to receive truthful financial information. A lie by omission is dishonest and inconsistent with the standards of behavior in the accounting profession.

What Should Wonderful Do?

Wonderful should inform Doolittle that he will take his concerns to Higgins. That may force Doolittle's hand and cause her to back off from pressuring Wonderful. As president of the company, Higgins has a right to know about the situation. After all, he hired Doolittle because of her expertise and, presumably, based on certain ethical expectations. Higgins may decide to disclose the matter immediately and cut his losses because this is the right thing to do. On the other hand, if Higgins persists in covering up the matter, then, after seeking outside/legal advice, Wonderful must decide whether to go outside the company. His conscience may move him in this direction. However, the confidentiality standard requires that he not do so unless legally required.

A Message for Students

As you can tell from the DigitPrint case, ethical matters in accounting are not easy to resolve. On one hand, the accountant feels an ethical obligation to his employer or the client. On the other hand, the profession has strong codes of ethics that require accountants and auditors to place the public interest ahead of all other interests. Accounting professionals should analyze conflicting situations and evaluate the ethics by considering professional standards and the moral principles discussed in this chapter. A decision should be made after careful consideration of these factors and by applying logical reasoning to resolve the dilemma.

Keep in mind that you may be in a position during your career where you feel pressured to remain silent about financial wrongdoing. You might rationalize that you didn't commit the unethical act, so your hands are clean. That's not good enough, though, as your ethical obligation to the public and the profession is to do whatever it takes to prevent a fraud from occurring and, if it does, take the necessary steps to correct the matter. We hope that you will internalize the ethical standards of the accounting profession, and look at the bigger picture when pressured by a superior to go along with financial wrongdoing. The road is littered with CFOs/CPAs who masterminded (or at least directed) financial frauds at companies such as Enron, WorldCom, and Tyco. The result of their trials was a jail sentence for Andy Fastow of 10 years, Scott Sullivan of 5 years, and Mark Swartz of 8 1/3 to 25 years. Most important is they lost their livelihood, as well as the respect of the community. A reputation for trust takes a long time to build, but it can be destroyed in no time at all.

(Professional Ethics 41)

Question: What was wrong and what should have been done and why: on p. 37-41, Digitprint & Wally Wonderful.