CASES 11. Year-End Adjusting Entries Eduardo Garcia has just been hired as the controller for Toro Enterprises. To become familiar with the company, he is reviewing the financial statements for 2013. The previous controller completed the year-end financial statements before he left and mailed them to the holder of the long-term bonds as required by the debt covenants. Eduardo is dismayed to find several errors in the financial statements. The previous controller, George Wilson, prepared several adjusting entries on January 10, 2014. The explanations for these entries were “to avoid default on the debt covenant”. George had recognized revenue on a large order received on December 28 but shipped on January 3, and had reduced deprecia-tion expense by $2,300,000. Both of these items were designed to increase earnings per share to the required amount. Required: a. What is the accounting and ethical problem for Eduardo? What pres-sure does Eduardo face?
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b. Based on your knowledge of accounting standards, what is the appro-priate accounting treatment for these items? c. Identify the stakeholders affected by the errors in the financial state-ments presented to the bondholders. Who benefits? Who is harmed? Is there a conflict of interest between the stakeholders? d. What alternatives are available to Eduardo? Is it worse to admit to the bondholders that your predecessor made a mistake than to hide it? e. What would you do? Why?
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