Is any option that Mary is considering acceptable under generally accepted accounting principles? Why or why not?
Do any of the options considered by Mary constitute financial statements fraud?
How would you handle the entire situation if you were in Mary’s shoes?
The problem with earnings had been caused by large bad debts from three clients who had been arrested for drug trafficking. Rbeck had entirely financed luxury yachts for the three clients because of their excellent credit history and prominence in the business community. However, the federal government seized all of the clients’ assets, leaving nothing for Rbeck but the three half-built yachts.
After thinking things over, Vanessa Rbeck asked Mary Milken to find a way to avoid having to report lower earnings because of her concern as to of how Annie might respond to the decline in earnings. Mary considered various options:
• Increase the estimated percentage of completion on all yachts in the work-in-process inventory by 15 percent. This would wipe out most of the loss. The work-in-process estimates have always been very conservative anyway.
• Recognize revenue on the three yachts in default. It would be very difficult to sell them at a good price, but she could always argue that they could be sold if she could keep a straight face. The best strategy would be to find new buyers for them, but that could take a couple of years.
• Switch to mark-to-market accounting for some of the yachts in progress so the company could recognize all of the profit when contracts with other clients are signed.
Mary Milken is the CFO of the Rbeck Company in Miami, Florida. The company is a closely held custom yacht builder with about 200 technical workers (engineers, marine architects, mechanics, boat workers, and so on), and 12 employees in its main office staff. Her primary job is to prepare the financial statements with the assistance of two full-time accountants. She normally follows generally accepted accounting principles, but she sometimes ignores them when she thinks they do not lead to what she considers best practices for the small number of her company’s shareholders.