You are hired as a corporate accountant for Ryco Industries, Inc., a public company with shares traded on the New York Stock Exchange. The company has enjoyed consistently higher earnings each quarter, meeting or exceeding the expectations of Wall Street analysts every quarter for the past seven years. Soon after being hired, you discover a "reserve" account in the accounting records. Your inquiry shows that the account is designed to accumulate earnings deficiencies or excesses, that is, to permit Ryco to adjust its earnings each quarter such that earnings not increase too little or too much. You bring your findings to the attention of Ryco's chief accounting officer, who tells you that the account merely allows Ryco to smooth or manage its earnings, something that Wall Street analysts want to see. If earnings fluctuated, she explains, analysts would make less optimistic estimates about the prospects of Ryco, and its stock price would take a hit. The CAO tells you, "Look, we're just doing this to avoid getting hammered in the stock market. Every company does this. And we're not making up earnings.
When actual earnings are too high, we just withhold recognizing some of those earnings until we need them in the future. When actual earnings are too low, we know we'll have better quarters in the future from which we can borrow earnings now. It all evens out." Can you identify the critical thinking errors and the characteristics of poor decision making that the CAO is exhibiting? Create a plan that will help you resist the CAO's request for you to continue to manage earnings as Ryco has done in the past.