Case 3 Cubbies Cable 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 ac

Case 3
Cubbies Cable
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 family-owned regional cable company headquartered in
Chicago. Binks is involved in a second dispute in three years with client management. The first
dispute concerned the disclosure of a contingent liability on a class-action lawsuit against
Cubbies for age discrimination in hiring. Cubbies did not disclose the possibility of loss even
though all signs pointed to a verdict against the company. Cubbies argued there was nothing to
confirm the CPA firm’s position in that regard and the company would only disclose it if they
lost the lawsuit.
The current dispute involves the capitalization of cable construction costs that the client
wants to expense. Binks reviewed a memorandum in the workpapers prepared by John
Kessinger, the audit manager. The document summarizes the facts on the second dispute. This
memo is presented in Exhibit 1.
Cubbies recently completed a major cable installation project at a condominium complex
across the street from Wrigley Field in Chicago. The revenue earned from that job enabled the
company to complete the third quarter of 2010 with record earnings. Revenues at September 30,
2010 exceeded revenues at September 30, 2009 by 22 percent. Net income for the nine months
ended September 30, 2010, 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. 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.
Binks contemplates his options – either to go along with the client’s position (the option
supported by Hondley) or to maintain his own position. It is at this point that he thinks about
another “Yogi-ism”; “when you come to a fork in the road, take it.” EXHIBIT 1
Memo on Capitalization of Cable Equipment
November 30, 2006
1. Cubbies Cable is a locally owned cable television company that services the neighborhoods
in Chicago that surround Wrigley Field, the home of the Chicago Cubs. Cubbies Cable was
incorporated as a closely held company in 2004. We have audited the company’s financial
statements since September 30, 2005. The audited statements are used by Chicago First
National Bank in granting short-term loans to Cubbies Cable. In particular, the company has
a debt covenant agreement with the bank that obligates Cubbies to maintain a specified level
of liquidity as indicated by the working capital and “quick” ratios.
2. During the twelve month period ending March 30, 2007 Cubbies constructed a new cable
system in parts of Chicago that enabled it to increase its presence in that market. The
revenue from the system through September 30, 2007, exceeded projections by more than
20%. The sharp increase over expected revenue was the cause of the conflict with the client.
3. A difference of opinion arose over the proper accounting for cable construction costs. The
client wanted to expense all of the costs in the year ended quarter ended September 30, 2007.
We suspect that the client wanted to decrease net income for the year. Two different types of
costs were involved:
a. Cable television plant: Costs associated with constructing the cable television plant
and providing cable service include head-end costs, cable, and drop costs. The client
wanted to expense all of these costs. However, Statement of Financial Accounting
Standards No. 51, “Financial Reporting by Cable Television Companies,” requires
that cable television plant costs incurred during the prematurity periods be capitalized
in full. We had protracted discussions with Cubbies Cable regarding this issue, and we were told there was no way the company would agree to capitalize any of the
costs. Given that Cubbies was not publicly-owned, our only recourse is to take the
matter to the board of directors. Another concern is that nine of the eleven members
of the board are family members of the CEO or past officers of Cubbies Cable. We
expect this situation to work against us in convincing the client that its proposed
accounting procedure is not in accordance with generally accepted accounting
principles.
b. Interest cost: The client initially expensed all costs during the prematurity period.
We convinced the client to change its accounting to capitalize costs during the
construction period. We used for support our reference to SFAS No. 51. This
Statement requires application of SFAS No. 34, “Capitalization of Interest Cost,” to
interest costs incurred during the construction of an asset. The application of
paragraphs 13 and 14 of SFAS No. 34 to the client’s situation requires that interest
costs incurred during the prematurity period be capitalized in full by applying the
interest capitalization rate to the average amount of accumulated expenditures for the
asset during the period. The purpose of this procedure is to capitalize the amount of
interest costs incurred during the prematurity period that theoretically could have
been avoided if expenditures for construction of the cable television plant had not
been made.
* See definitions in Exhibit 3, for all italicized words. EXHIBIT 3
Definitions of Terms from SFAS Nos. 28, 29, and 51 SFAS No. 51, “Financial Reporting by Cable Television Companies”
(Paragraph 17)
Cable Television Plant. This refers to the cable television system required to render services to
subscribers and includes the following equipment:
Head-End. The equipment used to receive television signals, including the studio
facilities required to transmit the programs to subscribers.
Cable. This consists of cable and amplifiers placed on utility poles or underground that
maintain the quality of the signal to subscribers.
Drops. This consists of the hardware that provides access to the main cable in order to
bring the signal from the main cable to the subscriber’s television set, and devices to
block channels.
Converters and descramblers. There are devices attached to the subscriber’s television
sets when more than 12 channels are provided, such as Pay-per-View programming or
two-way communication.
Prematurity Period. This refers to the period of time during which the cable television system is
partially under construction and partially in service. It begins with the first earned subscriber
revenue and ends with the completion of the first major construction period or achievement of a
specified, predetermined subscriber level at which no additional investment will be required,
other than that for cable television plant. This case deals with the issue of capitalization versus expensing of construction costs. And
subordination of judgment by an auditing firm.
Ethical Issues
The ethical issue for Binks is does he go along with the firm on this matter or should he try to do
something to influence the firm’s position. If he supports the firm, will it be an active and open expression of support or tacit approval? If he tries to change the firm’s position, then how will he
go about doing this? Accounting firms do not have boards of directors or audit committees that
become involved in resolving differences of opinion between those charged with engagement
responsibilities. It is possible, however, that the firm does have some kind of mechanism to
review difference, such as a technical standards review committee. If so, Binks should take his
concerns to this group.
If the firm does not have any mechanism in place to review internal differences of opinion on
accounting matters, then Binks will have to decide whether he feels strongly enough about this
matter to resign as a partner and sell his partnership interest. On a practical level, this probably
would not occur. From an ethical perspective, however, Binks needs to weigh his loyalty
obligation to the accounting firm against the need to honor the public trust. If he reasons at stage
4, as indicated in the case, then he will find it difficult to stand idly by while the GAAP rules are
violated. Binks may have no other option but to resign from the accounting firm, just as a
controller might be expected to do the same if there is a difference of opinion on an accounting
issue with top management of a company. QUESTIONS
1. What do you think was the motivation for Cubbies Cable in taking the position to
expense all cable costs during the nine months ended September 20, 2010? 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, or to take some other action. What would you do at this point if you were in
Binks’s position? Why?
3. Would you question the company’s integrity in this situation given that Cubbies did agree
with the firm on the issue of capitalizing interest during the prematurity period? In other
words, should CPAs be prepared to “horse trade” when dealing with a client about the
proper GAAP to apply in a particular situation?