Consider the following scenario:
Atlantis Company sells computer components and plans on borrowing some money to expand. After reading a lot about earnings management, Andy, the owner of Atlantis, has decided that he should try to accelerate some sales to improve his financial statement ratios. He has called his best customers and asked them to make their usual January purchases by December 31. He told them he would allow them until the end of February to pay for the purchases, just as if they had made their purchases in January.
Respond to the following questions:
- What do you think are the ethical implications of Andy’s actions? (1 to 2 paragraphs)
- Which ratios will be improved by accelerating these sales? (1 paragraph)
- Would you advise Andy to proceed with this plan? Why or why not? (1 to 2 paragraphs)
What do you think are the ethical implications of Andy’s actions?
The ethical implications of Andy’s actions are evaluated based on the method and purpose of sales acceleration. From the given scenario, it is clear that Atlantis Company is not in a strong financial position to be able to borrow money for expansion. The chosen method of sales acceleration is completely unethical because it might make the firm to wind up in a worse off financial position immediately after sales acceleration. The main objective of Atlantis Company is to improve its financial statement ratios. This is unethical because it intended to deceive lenders that will go through the financial statement before offering the Company some money for expansion (Valentzas and Broni, 2010).
The method of sales acceleration that Andy wants to use is unethical because it will automatically hurt future sales, and eventually hurt the company financially. In addition, Andy’s method of accelerating sales will create a false expectation of the future financial performance of the Atlantis Company. Suppose the company manages to improve its financial statement ratios and get money for expansion, the now expanded business may flop due to financial constraints (Valentzas and Broni, 2010).
2. Which ratios will be improved by accelerating these sales?
The ratios that will be improved by accelerating the sales include; Sales to Assets Ratio, Returns on Assets Ratio, and Return On Equity Ratio (Hossan, 2010). These three ratios are always improved by increasing sales and are therefore expected to improve when Andy accelerates sales. Sales to Assets Ratio is always used to demonstrate how well a company is effectively deploying its assets to generate sales. Return on Assets Ratio is usually used to demonstrate how effectively a company utilizes and deploys its assets to generate profits. Return On Equity Ratio demonstrates how well a company utilizes and deploys equity to generate profits (Hossan, 2010). If these three financial ratios are improved, the funding company will be cheated that Atlantis Company effectively deploys its assets and equity to generate sales and profits. Atlantis Company will therefore succeed in getting funds to expand its business.
3. Would you advise Andy to proceed with this plan? Why or why not?
I would not advise Andy to proceed with this plan. In case Atlantis Company will need a substantial amount of money to expand the business, the funding committee will have to review the company’s financial statement and compare it with those of the previous years. Any large discrepancy in sales between the past and current years will put the company into trouble because the funding committee will request Atlantis to justify the change. If they realize that Atlantis is forging its books in order to get money for expanding its business, the company’s expansion plans may flop completely because it may not get the money it intends to borrow.
The method of sales acceleration that Andy intends to use is not worth the risk because if Atlantis gets the money that it wants to borrow, it may not be able to cover debt service in the long run. I would therefore advise Atlantis Company to consider other long term methods of improving its financial ratios such as; proper allocation of assets, keeping all assets constant, selling underperforming assets, and reducing all expenses to their bare minimum (Hossan, 2010).