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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

Discuss the similarities and the differences between convertible debt and debt issued with stock warrants.

Briefly discuss the convergence efforts that are under way by the IASB and FASB in the area of dilutive securities and earnings per share.

Assume that Sarazan Company has a share-option plan for top management. Each share option represents the right to purchase a \(1 par value ordinary share in the future at a price equal to the fair value of the shares at the date of the grant. Sarazan has 5,000 share options outstanding, which were granted at the beginning of 2017. The following data relate to the option grant.

Exercise price for options \)40

Market price at grant date (January 1, 2017) \(40

Fair value of options at grant date (January 1, 2017) \)6

Service period 5 years

Instructions

(a) Prepare the journal entry(ies) for the first year of the share-option plan.

(b) Prepare the journal entry(ies) for the first year of the plan assuming that, rather than options, 700 shares of restricted shares were granted at the beginning of 2017.

(c) Now assume that the market price of Sarazan shares on the grant date was $45 per share. Repeat the requirements for (a) and (b).

(d) Sarazan would like to implement an employee share-purchase plan for rank-and-file employees, but it would like to avoid recording expense related to this plan. Explain how employee share-purchase plans are recorded?

What is meant by the term antidilution? Give an example.

GROUPWORK (Computation of Basic and Diluted EPS) Charles Austin of the controller’s office of Thompson

Corporation was given the assignment of determining the basic and diluted earnings per share values for the year ending

December 31, 2018. Austin has compiled the information listed below.

1. The company is authorized to issue 8,000,000 shares of \(10 par value common stock. As of December 31, 2017, 2,000,000

shares had been issued and were outstanding.

2. The per share market prices of the common stock on selected dates were as follows.

Price per Share

July 1, 2017 \)20.00

January 1, 2018 21.00

April 1, 2018 25.00

July 1, 2018 11.00

August 1, 2018 10.50

November 1, 2018 9.00

December 31, 2018 10.00

3. A total of 700,000 shares of an authorized 1,200,000 shares of convertible preferred stock had been issued on July 1, 2017.

The stock was issued at its par value of \(25, and it has a cumulative dividend of \)3 per share. The stock is convertible into

common stock at the rate of one share of convertible preferred for one share of common. The rate of conversion is to be

automatically adjusted for stock splits and stock dividends. Dividends are paid quarterly on September 30, December 31,

March 31, and June 30.

4. Thompson Corporation is subject to a 40% income tax rate.

5. The after-tax net income for the year ended December 31, 2018, was \(11,550,000.

The following specific activities took place during 2018.

1. January 1—A 5% common stock dividend was issued. The dividend had been declared on December 1, 2017, to all stockholders

of record on December 29, 2017.

2. April 1—A total of 400,000 shares of the \)3 convertible preferred stock was converted into common stock. The company

issued new common stock and retired the preferred stock. This was the only conversion of the preferred stock during 2018.

3. July 1—A 2-for-1 split of the common stock became effective on this date. The board of directors had authorized the split

on June 1.

4. August 1—A total of 300,000 shares of common stock were issued to acquire a factory building.

5. November 1—A total of 24,000 shares of common stock were purchased on the open market at \(9 per share. These shares

were to be held as treasury stock and were still in the treasury as of December 31, 2018.

6. Common stock cash dividends—Cash dividends to common stockholders were declared and paid as follows.

April 15—\)0.30 per share

October 15—$0.20 per share

7. Preferred stock cash dividends—Cash dividends to preferred stockholders were declared and paid as scheduled.

Instructions

(a) Determine the number of shares used to compute basic earnings per share for the year ended December 31, 2018.

(b) Determine the number of shares used to compute diluted earnings per share for the year ended December 31, 2018.

(c) Compute the adjusted net income to be used as the numerator in the basic earnings per share calculation for the year

ended December 31, 2018.
See all solutions

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