Case 1-6 Capitalization versus Expensing

Gloria Hernandez is the controller of a public company. She just
completed a meeting with her superior, John Harrison, who is the CFO of
the company. Harrison tried to convince Hernandez to go along with his
proposal to combine 12 expenditures for repair and maintenance of a
plant asset into one amount ($1 million). Each of the expenditures is
less than $100,000, the cutoff point for capitalizing expenditures as an
asset and depreciating it over the useful life. Hernandez asked for
time to think about the matter. As the controller and chief accounting
officer of the company, Hernandez knows it’s her responsibility to
decide how to record the expenditures. She knows that the $1 million
amount is material to earnings and the rules in accounting require
expensing of each individual item, not capitalization. However, she is
under a great deal of pressure to go along with capitalization to boost
earnings and meet financial analysts’ earnings expectations, and provide
for a bonus to top management including herself. Her job may be at
stake, and she doesn’t want to disappoint her boss.

Questions

Assume both Hernandez and Harrison hold the CPA and CMA designations.

1. What are the loyalty obligations of both parties in this case?
2. Assume
   that you were in Gloria Hernandez’s position. What would motivate you
   to speak up and act or to stay silent? Would it make a difference if
   Harrison promised this was a one-time request?
3. What would you do and why?