Sandretto, June 2, 2010
Synopses: Cases in Financial Reporting
Chapter 1, Introductory Cases
- Dublin Small Animal Clinic, Inc.
1 page; introductory
Accounting cycle
Journal entries
Income statement
Balance sheet
This brief case covers the accounting cycle for a start-up veterinarian practice. The first section includes only cash transactions; the second section includes accruals. Students make simple journal entries and then prepare an income statement and balance sheet. The case includes an Excel tutorial that lets students click buttons to make journal entries. As a journal entry is made, the program automatically updates the income statement and balance sheet. The tutorial also includes detailed explanations for the accounting process and for each journal entry. This case is a good introduction to financial accounting for first-year MBA or Executive MBA students.
Best uses:
First-year MBA/Executive MBA financial accounting
- Verona Springs Mineral Water
2 pages; introductory
Accounting cycle
Journal entries
Income statement
Balance sheet
Statement of cash flows
This case covers the accounting cycle for a start-up water bottling firm. It is similar to Dublin Small Animal Clinic, but the Excel tutorial also includes a chart of accounts and an integrated statement of cash flows that is updated as the balance sheet and income statement are updated. This case is a good follow-up to Dublin Small Animal Clinic to reinforce the concepts behind double entry bookkeeping, journal entries, the accounting cycle, and financial statements.
Best uses:
First-year MBA/Executive MBA financial accounting
- Holton-Central Holdings, Inc.
2 pages; intermediate
Accounting cycle
Journal entries
Income statement
Balance sheet
Inventory journal entries
Holton-Central Holdings covers the accounting cycle for a manufacturing firm acquired out of bankruptcy. It is more complicated than Dublin Small Animal Clinic or Verona Springs Mineral Water because it is an existing company, covers journal entries for raw material, work-in-process, and finished goods inventory, and includes a number of additional accounting topics. The case is excellent as a review and expansion of the material covered in those two introductory cases.
Best uses:
Undergraduate financial accounting, either as an introduction or as a review
First-year MBA/Executive MBA financial accounting
- Chang Medical Electronics
2 pages; introductory
Bond valuation
Zero-coupon bonds
Bond refinancing
A private equity partner evaluates three possible bond issues that can be used to acquire a privately held firm; the case includes details of each bond issue. The case can be used to cover: (a) the basics of bond pricing, bond yields, zero-coupon bonds, and bond refinancing; (b) accounting for issued bonds, including the effective interest method, or; a combination of the two. This is an introductory bond case that can be used to develop a basic understanding of bonds prior to covering the topic in more detail in cases such as Sirius XM Radio (bond issue combined with preferred stock to avoid bankruptcy—Chapter 3); Harley-Davidson (A) (rapidly increasing long-term debt when the securitization market collapsed in early 2008—Chapter 5), or;Knowles Electronics (private equity acquisition with equity and substantial debt—Chapter 6).
Best uses:
Undergraduate intermediate accounting
First-year MBA/Executive MBA financial accounting
Use with:
Discounted Cash Flows and the Time Value of Money (Chapter 7)
Note on Bonds (Chapter 7)
Brief Excel Case: Fixed Income Securities (Bonds) (Chapter 8)
- Janet O’Brien
4 pages; introductory
Cost-based reimbursement
Need for rules
Need for auditing
I often passthis case out the first day of class to get students comfortable talking in class. The case covers cost-based Medicaid nursing home reimbursements, which are managed by individual states but funded about equally by each state and the federal government. In the state in which the case is situated, there were few rules about allowable costs and the Governor did not believe the state should interfere with private enterprise. The state had not audited nursing homes for seven or eight years. Over time, the nursing homes became increasingly aggressive in billing the state for high and possibly unallowable costs. Nursing homes billed the state and were reimbursed for items such as educational trips to Hawaii, house boats, mobile homes, high-end automobiles (Mercedes, BMW, and Rolls Royce), high salaries for relatives, and high payments to relatives for items such as lease and service contracts.
The case is easy to understand and most students participate in the discussion. It can be used to discuss why we have accounting rules and audits. It can also be used to discuss why cost-based reimbursement is so complex and why contracts between a governmental unit and private enterprise are so difficult to control; thus leading to an understanding of why alleged fraud is so common. The case takes 10 minutes to read and can be used for a 30-90 minute discussion.
Best uses:
Ethics
Undergraduate intermediate accounting
Undergraduatemanagerial or cost accounting
First-year MBA/Executive MBA financial or managerial accounting
Executive education
- Big Cat HPV LLC
24 pages; intermediate
Startups
Financial statements
Product pricing/product features
Competitive/strategic analysis
Product costs
Production control
General management
This case covers the first ten years of operations for a startup recumbent tricycle manufacturer, Big Cat HPV LLC. The case follows Paulo Camasmie and explores the wide range of business issues he experienced when he moved from Brazil to the U.S. in 2000 to start his own firm building recumbent tricycles.As of 2010, Big Cat was the world’s largest recumbent tricycle manufacturer having just introduced its first recumbent bicycle, which was an immediate success. The issuesdiscussed include distribution, marketing, sales, product design, production control, cost control, product features, and competitive analysis. All of that can be integrated with the firm’s actual income statements from 2000 through 2007 (later years are omitted for confidentiality).
The case can be used in a wide range of courses. I have taught it in both managerial and financial accounting courses but it can be used in general management, production, marketing, or strategy/policy courses because it covers everything Paulo considered important for his firm during the first ten years of the firm’s operations.
A primary issue is shipping costs. Recumbent tricycles occupy a large amount of shipping space per dollar of production cost; recumbent bicycles occupy less space per dollar of production cost. The case also includes enough cost information that students can evaluate whether Paulo can compete with low-cost producers from Taiwan in 2010, and possibly even lower cost producers from China within a few years.
The case does not include balance sheets, but students can prepare estimated balance sheets based on information in the case. They can also evaluate Big Cat’s prospects for the future.
Best uses:
Undergraduatemanagerial or cost accounting
First-year MBA/Executive MBA financial or managerial accounting
Executive education
Valuation
A wide range of other MBA courses
Chapter 2, Corporate Governance and Regulation
- Accounting Irregularities at Xerox
7 pages; intermediate
Corporate governance
Sales-type leases
Understated discount rates
Accounting manipulation
Sec investigation
This case discusses Xerox’s use of low discount rates for its sales-type (capital) leases in South America, and a number of other lease accounting issues. The issues arose when an assistant controller, whose father was a prominent Connecticut judge, raised questions about Xerox’s lease accounting in August 2000. He was fired two days later for “unrelated” reasons.
The SEC began an investigation but management protested that this was nothing more thanuninformed opinion from a disgruntled former employee. KPMG forced Xerox to delay its 2000 annual report and then forced Xerox to write down about $350 million of pre-tax profits because of problem leases. Xerox fired KPMG for “unrelated” reasons and then hired PwC, with the expectation that there would be no further write-downs. That might have been the end of the matter but in late 2001 Enron collapsed. It was clear that Arthur Andersen might be forced out of business and that the entire accounting industry would be under far greater scrutiny.
Possibly because of the outrage towards the accounting profession, PwC forced Xerox to write off an additional $1.9 billion of profits in 2001. Senior Xerox executives resigned and the SEC extracted large fines from KPMG, Xerox, and senior Xerox executives.
The case discusses seven accounting issues raised by the SEC, most of which relate to leases. The case can be used to cover lease basics and numerous other lease issues that can arise in practice. The case can be used in conjunction with Lease Restatements in the Restaurant Industry: 2004-2005, which covers several other lease accounting issues, primarily for operating leases.
Best uses:
Ethics
Undergraduate intermediate accounting
First-year MBA/Executive MBA financial accounting
Financial reporting
Financial statement analysis
Valuation
Use with:
Brief Excel Case: Leases (Chapter 8)
- Microsoft Corp: Financial Reporting Issues
16 pages; intermediate
Corporate governance
Accruals
Materiality
Documentation
SEC investigation
This case covers Microsoft’s consent decree with the SEC over unsupported accounting accruals. It is an excellent governance case and also covers numerous accrual issues. Microsoft had very well designed systems at the operating level to prepare and monitor accruals. However, very senior management then made large unsupported accrual journal entries to a general account, allegedly to reach earnings targets. When SEC officials aligned the unsupported adjustments with relevant accounts, they discovered that for one quarter Microsoft actually had negative inventory.
Those activities occurred before Sarbanes-Oxley made such practices subject to civil and criminal penalties. As a result, Microsoft signed a consent decree whereby it neither denied nor admitted guilt, but promised to not engage in those practices in the future. There were no fines and no criminal charges against Microsoft.
The case can be used to discuss several accrual accounting issues. It can also be used to consider what can be done to prevent senior management from overriding internal controls. Finally, the case can be used to consider the motives of senior management. At the time, Microsoft was incredibly profitable, growing rapidly, and had a near monopoly on personal computersoftware. The adjustments were almost certainly immaterial, probably had little effect on Microsoft’s market value, and the firm’s key shareholders (Bill Gates and senior Microsoft executives) were neither buying nor selling shares.
Microsoft and many other firms routinely reported earnings per share in excess of analysts’ consensus forecasts. The entire process seemed designed to beat the consensus forecasts for revenues and earnings. Given Microsoft’s market dominance and its fluctuating revenues as it released new versions of Office and Windows, it seems unlikely that Microsoft’s market value would have declined much if revenues or earnings were slightly lower than consensus estimates, since Microsoft still had 95% of the Office and Windows markets.
Best uses:
Ethics
Undergraduate intermediate accounting
First-year MBA/Executive MBA financial accounting
Financial reporting
Financial statement analysis
Executive education
- Beazer Homes USA, Inc.: SEC v. Michael T. Rand, Chief Accounting Officer
21 pages; intermediate
Corporate governance
Accruals
Materiality
Documentation
SEC investigation
Beazer homes was the sixth largest U.S. home builder during the 1998-2006 housing boom. Like other major home builders, Beazer’s market value grew by a factor of 8-10 during that period. However, the new home market slowed in 2006 and then collapsed in 2007.
The SEC alleged that Michael T. Rand, Beazer’s chief accounting officer, understated Beazer’s reported profits in every quarter but one from 2000 through 2005 by understating Beazer’s “land inventory” account and by overstating its “cost to complete” reserve. The SEC further alleged that during each of the four quarters in 2006, and in the first quarter of 2007, Mr. Rand increased Beazer’s reported profits by increasing the “land inventory” account, decreasing the “cost to complete” reserve, and fraudulently recording sale-and-leaseback transactions for model homes.
The case provides an excellent overviewof the U.S. housing boom and collapse. It can be used prior to New Century Financial Corp(Chapter 3), which covers the collapse of a sub-prime and Alt A mortgage lender. The case is also excellent for covering the practical issues of accrual accounting in uncertain environments.
The SEC charges imply that it is relatively simple to estimate the value of the firm’s “land inventory” and “cost to complete” accounts. The SEC’s complaints on these matters made the valuation process for each process seem far more objective than it actually is in practice, particularly for a rapidly growing firm that almost certainly was relying on less experienced managers and workers, and less experienced accountants.
The case also covers a sale-and-leaseback transaction. Those accounting rules are complex, so again, it might not be clear that Mr. Rand engaged in fraud.
Finally, the cumulative alleged profit understatement for 2000-2005 was about $72 million for a firm that had about $2 billion of operating profits. In addition, during nine quarters from 2007-2009, Beazer recorded about $1 billion of impairment charges. Given theimplicit subjectivity in those nine impairment charges, it seems highly likely that the “land inventory” and “cost to complete” accounts were also highly subjective numbers.
I use this case to consider the subjectivity of various accrual accounts. I also use it to consider who would make the accrual calculations. Beazer constructed housing developments throughout the nation. Michael T. Rand almost certainly was not personally responsible for preparing accrual estimates at the operating level.
Best uses:
Ethics
Undergraduate intermediate accounting
First-year MBA/Executive MBA financial accounting
Financial reporting
Financial statement analysis
Valuation
Executive education
- Corporate Governance at IBM and Google
16 pages; intermediate
Corporate value statements
Corporate governance
Business judgment and competing interests
Ethics
IBM and Google are highly profitable and in many ways are among the world’s most ethical companies. Both have impressive and lofty corporate value statements with parts that could be used for not-for-profit organizations. However, IBM and Google are publicly traded and employ tens of thousands of employees—they are not charitable organizations. As they react to competitive challenges, they sometimes need to reduce salaries or benefits, or engage in actions that seriously harm their competitors.
This case includes three instances where IBM faces difficult choices and its value statements seem to be of limited value (reduced pension benefits; lower salaries, and; competitive actions to protect their mainframe business). The case also includes seven instances where Google faces complicated decisions. In six of the instances, Google seems to be going against its value statements and violating various laws. However, in the seventh instance, Google stands up to Chinese censors at potentially great cost.
I use the case to discuss difficult choices corporations often face. I also use it to discuss the real value of value statements.
Best uses:
Ethics
Undergraduate intermediate accounting
First-year MBA/Executive MBA financial accounting
Executive education
- Chrysler, LLC: Bankruptcy
12 pages; intermediate to advanced
Corporate governance
Bankruptcy
Priority in bankruptcy
National policy and competing interests
Chrysler and General Motors received large U.S. government loans shortly before George Bush left office. As President Obama entered office, it was obvious that Chrysler and General Motors would need additional funding to continue operating. A bankruptcy would be extraordinarily costly and might put thousands of employees out of work just as the economy entered the worst recession since the Great Depression. It seemed highly unlikely any private investor would invest in either firm.
In response, the government proposed a plan for a rapid exit through a Chapter 11 bankruptcy reorganization thatwould circumvent the legal priority of creditors in bankruptcy. That led some to question whether the plan might lead to a lack of faith in contract law and the courts. However, that does not seem to have occurred.