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Chapter 16: Q16-2CA (page 885)

CA16-2 ETHICS (Ethical Issues—Compensation Plan) The executive officers of Rouse Corporation have a performance-based compensation plan. The performance criteria of this plan is linked to growth in earnings per share. When annual EPS growth is 12%, the Rouse executives earn 100% of the shares; if growth is 16%, they earn 125%. If EPS growth is lower than 8%, the executives receive no additional compensation.

In 2014, Joan Devers, the controller of Rouse, reviews year-end estimates of bad debt expense and warranty expense. She calculates the EPS growth at 15%. Kurt Adkins, a member of the executive group, remarks over lunch one day that the estimate of bad debt expense might be decreased, increasing EPS growth to 16.1%. Devers is not sure she should do this because she believes that the current estimate of bad debts is sound. On the other hand, she recognizes that a great deal of subjectivity is involved in the computation.

Instructions

Answer the following questions.

(a) What, if any, is the ethical dilemma for Devers?

(b) Should Devers’s knowledge of the compensation plan be a factor that influences her estimate?

(c) How should Devers respond to Adkins’s request?

Short Answer

Expert verified

Answer

  1. Ethical dilemma for Devers includes benefits generated by Adkins and executives working in the business entity.
  2. Compensation plans must not influence the decisions of the accountant.
  3. Adkins’s request for alteration of estimates must be denied.

Step by step solution

01

Step-by-Step SolutionStep 1: Definition of Ethical Activities

Activities that prove to be fair from the point of view of moral principles are known as ethical activities. Such activities respect each type of individual and group.

02

Ethical dilemma for Devers

Alteration of the bad debt estimates will benefit Adkins and the other executives of the business entity. Such alteration will not be ethical because current estimates are sound, according to Devers’s judgment.

03

Factor influencing estimate

Decisions of the accountant must not be affected by the compensation plans of the business entity. Instead, it must be independent and fair.

04

Devers response to Adkins

Devers must deny the request of Adkins because altering the estimate is unethical, and the current estimates are fair and sound.

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Most popular questions from this chapter

(Conversion of Bonds) On January 1, 2016, when its \(30 par value common stock was selling for \)80 per share, Plato Corp. issued \(10,000,000 of 8% convertible debentures due in 20 years. The conversion option allowed the holder of each \)1,000 bond to convert the bond into five shares of the corporation’s common stock. The debentures were issued for \(10,800,000.The present value of the bond payments at the time of issuance was \)8,500,000, and the corporation believes the difference between the present value and the amount paid is attributable to the conversion feature. On January 1, 2017, the corporation’s \(30 par value common stock was split 2 for 1, and the conversion rate for the bonds was adjusted accordingly. On January 1, 2018, when the corporation’s \)15 par value common stock was selling for $135 per share, holders of 30% of the convertible debentures exercisedtheir conversion options. The corporation uses the straight-line method for amortizing anybond discounts or premiums.

a) Prepare in general journal form the entry to record the original issuance of the convertible debentures.

(b) Prepare in general journal form the entry to record the exercise of the conversion option, using the book value method.

Show supporting computations in good form.

(Issuance and Conversion of Bonds) For each of the unrelated transactions described below, present the entry(ies) required to record each transaction.

1. Grand Corp. issued \(20,000,000 par value 10% convertible bonds at 99. If the bonds had not been convertible, the company’s investment banker estimates they would have been sold at 95.

2. Hoosier Company issued \)20,000,000 par value 10% bonds at 98. One detachable stock purchase warrant was issued with each \(100 par value bond. At the time of issuance, the warrants were selling for \)4.

3. Suppose Sepracor, Inc. called its convertible debt in 2017. Assume the following related to the transaction. The 11%, \(10,000,000 par value bonds were converted into 1,000,000 shares of \)1 par value common stock on July 1, 2017. On July 1, there was \(55,000 of unamortized discount applicable to the bonds, and the company paid an additional \)75,000 to the bondholders to induce conversion of all the bonds. The company records the conversion using the book value method.

(Conversion of Bonds) Vargo Company has bonds payable outstanding in the amount of \(500,000, and the Premium on Bonds Payable account has a balance of \)7,500. Each \(1,000 bond is convertible into 20 shares of preferred stock of parvalue of \)50 per share. All bonds are converted into preferred stock.

(Issuance, Exercise, and Termination of Stock Options) On January 1, 2016, Nichols Corporation granted 10,000 options to key executives. Each option allows the executive to purchase one share of Nichols’ \(5 par value common stock at a price of \)20 per share. The options were exercisable within a 2-year period beginning January 1, 2018, if the grantee is still employed by the company at the time of the exercise. On the grant date, Nichols’ stock was trading at \(25 per share, and a fairvalue option-pricing model determines total compensation to be \)400,000.On May 1, 2018, 8,000 options were exercised when the market price of Nichols’ stock was $30 per share. The remaining options lapsed in 2020 because executives decided not to exercise their options.

Instructions

Prepare the necessary journal entries related to the stock option plan for the years 2016 through 2020.

16-18 (L04) (EPS: Simple Capital Structure) Flagstad Inc. presented the following data.

Net income \(2,500,000

Preferred stock: 50,000 shares outstanding,

\)100 par, 8% cumulative, not convertible 5,000,000

Common stock: Shares outstanding 1/1 750,000

Issued for cash, 5/1 300,000

Acquired treasury stock for cash, 8/1 150,000

2-for-1 stock split, 10/1

Instructions

Compute earnings per share.
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