On December 12, 2002, the U.S. Securities and Exchange Commission (SEC) filed a lawsuit against four executives of Safety-Kleen Corp., a leading provider of industrial waste collection and disposal services. The primary issue was that the executives had directed others in the company to record improper adjustments in 1999 and 2000, which had the effect of overstating net income during those periods. The following table was included in the SEC's court documents to demonstrate the (combined) effect of proper and improper adjustments on net income. (All amounts are in millions.)

The following excerpts from the SEC's complaint describe two of the allegedly improper adjustments:

Required
1. Discuss whether large adjustments, such as those included by Safety-Kleen in 1999 and 2000, necessarily indicate improper accounting procedures.
2. What does the SEC's document mean in paragraph 26 when it says three top executives "improperly recorded several adjusting entries to capitalize certain operating expenses"? Drawing on concepts presented in Chapters 2 and 3, explain why it is improper to record payroll expenses for marketing personnel as assets.
3. Assume the $7.6 million in bonuses referred to in paragraph 33 were recorded in the third quarter of 1999. What journal entry would have been used to record this accrual? Assume this accrual was eliminated in the fourth quarter of 1999. What adjusting journal entry would have been recorded to eliminate (remove) the previous accrual? What journal entry would have been used to record the $7.6 million in bonuses paid in the first quarter of 2000 (assuming the accrual had been removed in the fourth quarter of 1999)? What accounting concept is violated by recording an expense for management bonuses when they are paid rather than when they are earned by managers?
Epilogue: In April 2005, a federal judge found the company's former CEO and CFO liable for $200 million for their role in the fraud.

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Year (Quarter) 1999 (Q1) 1999 (Q2) 1999 (Q3) $ 76.7 1999 (Q4) 2000 (QI) Net income before adjustments $ 90.9 36.6 $ 57.3 $ 47.0 $ 47.9 Effect of adjustments Net income after adjustments 30.9 75.5 53.1 69.8 $123.4 $116.8 $127.5 $107.6 $110.4 Improper Capitalization of Operating Expenses 26. As part of the fraudulent accounting scheme, [three top executives] improperly recorded several adjusting entries to capitalize certoin operating expenses. These adjustments caused the company to materially overstate both its ossets and its earnings. For example, at the end of the third quarter of fiscal 1999, they improperly copitalized approximately $4.6 million of payroll expenses reloting to certain marketing and start-up activities. Improper Treatment of Accruals 33. During the fourth quarter of fiscal 1999, Humphreys [the CFO) created additional fictitious income by directing [other accounting executives] to eliminate a $7.6 millian cccrual that had been established to provide for management bonuses that had been earned in fiscal 1999, but were to be paid the following quarter. Humphreys' oction suggested that no bonuses were going to be paid for that year. In fact, the bonuses for 1999 were paid as scheduled.