Ernie Binks is a big baseball fan, so it is quite natural for him, at a time like this, to recall a phrase attributed to Yogi Berra: "It was déjà vu all over again." Binks is the partner in charge of the Cubbies Cable audit for the accounting firm of Santos & Williams LLP. Cubbies is a publicly-owned cable company headquartered in Chicago. A situation arose with the client over the proper accounting for cable installation costs in the year-ended September 30, 2013, financial statements.
The client wants to expense the costs while the audit manager has recommended capitalization. It is important to resolve the issue quickly because the client will use the September 30, 2013, audited annual statements to apply for a $10 million loan at one of two banks- Chicago First National or Bankers Trust. Binks reviewed a memorandum prepared by John Kessinger, the audit manager, that details the accounting issues. This memo is presented in Exhibit 1. The revenue earned from the cable installation job enabled the company to complete the fourth quarter of 2013 with Case 7-3 Cubbies Cable record earnings. Revenues at September 30, 2013, exceeded revenues at September 30, 2012, by 22 percent.
Net income for the twelve months ended September 30, 2013, was 24 percent above the same amount in the prior year. Binks is now preparing for a meeting with Rod Hondley, the advisory partner on the Cubbies Cable audit. Hondley has already made it known that he supports the client's position on the cable installation costs. Binks knows Santos & Williams operates by the simple philosophy that you have to let the client win one somewhere along the line or you may lose that client.
The dilemma for Binks is he is in the uncomfortable position of going against the recommendation of the audit manager if he agrees to the client's position that Hondley supports. Binks thinks about the fact that the situation is unique in that the client's preferred accounting treatment would actually lower earnings for the year-ended September 30, 2013, and increase it in subsequent years. He considers his options and reflects on another "Yogi-ism": "When you come to a fork in the road, take it."
Questions
1. What do you think was the motivation for Cubbies Cable in taking the position to expense all cable costs during the year ended September 20, 2013. Would you characterize the position as an attempt to manage earnings? Why or why not?
2. Who are the stakeholders in this situation? Identify the major ethical issues that should be of concern to Binks in deciding whether to just go along with the firm in its support of the client (based on Hondley's position) or support the position of the audit manager. What would you do if you were in Binks's position? Why?
3. Do you think it is ethical for CPAs to "horse trade" when negotiating with a client about the proper GAAP to apply in a particular situation? How does such negotiating relate to the accepted auditing standards of the AICPA and PCAOB discussed?