First, the conversation itself would throw red flags and I would be extremely leery of requests
such as the one in the scenario, and in the future. As the accountant, there are both
professional and ethical responsibilities that one must follow to produce work in an
appropriate manner. As far as interest during construction, there are three issues that GAAP
identifies:
“Does the asset quality for interest capitalization?” (Whalen, Jones, & Pagach, 2017)
“Over what period can interest be capitalized?” (Whalen, Jones, & Pagach, 2017)
“What amount of interest can be capitalized?” (Whalen, Jones, & Pagach, 2017)
In addition, and more importantly in regards to this scenario, the question becomes when
interest can be capitalized on. d The three tests for when interest capitalization period begins is,
“(1) expenditures for the asset have begun, (2) activities that are necessary to get the asset
ready for its intended use are in progress, and (3) interest cost is being incurred” (Whalen,
Jones, & Pagach, 2017). Looking at the time frame with the construction beginning June of
2016, this alone would tell me that interest cannot be doubled back to previous years, such as
2015, which I would convey as being both financially and ethically wrong.
In regards to the addition of “lots of overhead,” ethically I would be concerned and deny such
a request because overhead costs must be “represented faithfully” that only includes “the
additional costs incurred to produce it” (Whalen, Jones, & Pagach, 2017). While some time
was spent on the project, naturally, the request to specifically increase the profits by adding ½
of the salary is wrong financially and ethically. This specific request would throw red flags
and I would not be comfortable doing such.
As the Accountant for this company, when approached by the CEO with such unethical
requests, I would remind the CEO that I have an ethical responsibility to the Company to
ensure that the financial representation of the company is in accordance with GAAP.
Based on a construction start date of June 2016, the company is not eligible to capitalize
interest for 2015 and modifying current year expenses to account for prior year interest, and
capitalization of “lots of overhead” and current year salary would be considered unethical and
fraudulent. I would attempt to explain the three questions identified by GAAP; “Does the
asset qualify for interest Capitalization,” “Over what period can interest be capitalized”, and
“What amount of interest can be capitalized” (Whalen, Jones, & Pagach, 2017), but based on
the CEO’s previous requests, I am not confident that the CEO would be receptive to my
explanation, or refusal to comply with their request.
As difficult as such action could be, request from a CEO that implicates fraudulent and/or
unethical behaviour and financial reporting should be reported immediately.
When it comes to case study 10-7 (“Ethics and Construction Costs”) my reply to the CEO
would be that what he is asking me is not only unethical, but it goes against GAAP standards
as well. The first concern for me would be the CEO insinuating that the company could
capitalize on interest from the planning period that started in 2015. However, the construction
of the building did not start until June 2016. As stated in our textbook “The capitalization
period begins when (1) expenditures for the asset have begun, (2) activities that are necessary
to get the asset ready for its intended use are in progress, and (3) interest cost is being
incurred. Interest capitalization continues if the three conditions are present.” (Wahlen, 2017).
This clearly shows that during the planning stage there is no interest to be capitalized, and the
capitalization is not to begin until the building construction is in progress.
The next issue is when the CEO asked me to increase the overhead by adding 1/12 of my
salary to the cost of the building to increase the profit for the year. Wahlen also states in our
textbook that interest is to be capitalized if the cost could have been avoided if the
construction had not happened. In this case, I have a salary, therefore this cost could not have
been avoided because it would have been the same whether there was construction of the
building or not. Again, this is not only unethical but fraudulent due to falsifying the financial
statement.
Clearly, the CEO knows what he is asking of me, as he asks “You get the idea?” This CEO is
asking me to go against many GAAP principles. These include but are not limited to Principle
of Regularity, Principle of Sincerity, Principle of Utmost Good Faith, Principle of Non-
Compensation, etc. In regards to this, I would for one not adhere to the CEO’s request. I
would also report these unethical circumstances to the FASB and SEC. I am sure this is not
the first time the CEO has made requests of this nature, and it will not be the last. I would also
contact the ethics hotline (Principal, 2022), to report the fraud and unethical reporting the
CEO tried to have me act on.
I understand your desire to improve the company books to give the shareholders a positive
look at the past year. However, those shareholders rely on us to provide a truthful and
accurate representation of their standings. As an accountant, I can uphold the GAAP and
follow the Code of Professional Conduct. What you are asking for is unethical and destroys
our company's integrity.
Since we did not start any work on the property until 2016, there are no expenses to report in
2015. The GAAP is clear the overhead costs must be tied directly to the construction of the
asset; as such, my salary does not fall under this category. It should also be noted that while it
may make the books look good this quarter, it will hurt the company in the long run. The
inflated overhead costs will not be considered down the road when we need to record a fair
value of the asset, and this additional overhead with end up showing as a loss. It would be
better for the company to keep the figures correct so that both present and future reports have
an exact economic cost.
On capitalizing on the interest for the project, we do not meet the three measures the GAAP
uses to allow this allocation. First, the project was not in development yet in 2015; thus, the
only asset was land that could not have interest capitalization added to it. Secondly, we have
to look at the period when the company is allowed to capitalize on the interest. To count
capitalization of interest, there must be activity or expenditures to have begun on the asset.
Thirdly, if you were allowed to capitalize the interest, you must determine the amount. To do
this, we would have to determine how much of the interest could have been avoided if the
construction had not occurred. Since there was no construction in progress in 2015, there is no
basis for determining the amount of interest.
This type of dilemma gives me a headache every time, and hammers home, to me, why I plan
on going into business for myself and helping small business owners get off on the right foot.
It did make me start wondering about somethings, so I went down the rabbit hole of IRS
publications and was reminded why I do not want to go into a business primarily doing taxes.
Why would he even think that anything was capitalized in 2015 when there were zero
expenditures until June 2016? I must believe that there is no way that anyone makes it to CEO
level without knowing the basic concepts of accounting. It made me wonder if he started
paying the architect when he sent off the first letter. Maybe he thought that he could capitalize
that? Even then, Wahlen is very clear about when the capitalization period begins: "The
capitalization period begins when (1) expenditures for the asset have begun, (2) activities that
are necessary to get the asset ready for its intended use are in progress, and (3) interest cost is
being incurred. Interest capitalization continues as long as the three conditions are present."
An initial consultation with an architect would not be the beginning of the expenditures. As
strange as his requests seems, I would like to get more information before I assume that the
CEO of a company that I work for is that clueless.
With all that being said, and assuming that the CEO is completely clueless, I would inform
him that he cannot capitalize anything until the actual process begins. Not only would it not
be legal, it would skew the financial statement numbers in a way that is unethical. As would
adding "lots of overhead" to the expenses of the project. All these figures should have been
stated before the project was started, so that the finance portion of the construction could be
figured accordingly. Coming in six or seven months after the project has started, and throwing
numbers around is completely unethical, and could also be illegal. Specifically speaking to
1/12 of my salary being capitalized for the construction, Wahlen states "The amount of
interest capitalized for a qualifying asset is the portion of the interest cost that could have
been avoided if the construction had not occurred." My salary would have been the same with
or without the construction. Maybe next year, the CEO can pay me extra for the time spent on
the project and that can be capitalized?
Wahlen, James M., et al. Intermediate Accounting: Reporting and Analysis. Cengage
Learning, 2017.
Reference
Wahlen, J. M., Jones, J. P., & Pagach, D. (2016). Intermediate Accounting: Reporting and
Analysis, 2017 Update (2nd ed.). Cengage Learning.
https://ng.cengage.com/static/nb/ui/evo/index.html?eISBN=9781337119146&snapshotId=37
2031&id=124839364&
Report fraud or unethical conduct. Principal. (n.d.). Retrieved March 10, 2022, from
https://www.principal.com/about-us/our-company/policies/report-fraud-or-unethical-conduct
Wahlen, James M., et al. Intermediate Accounting: Reporting and Analysis. Cengage
Learning, 2017.
Whalen, J. M., Jones, J. P., & Pagach, D. P. (2017). Intermediate Accounting: Reporting and
Analysis. Boston, MA: Cengage Learning.
Whalen, J. M., Jones, J. P., & Pagach, D. P. (2017). Intermediate accounting: Reporting and
analysis. Boston, MA: Cengage Learning.
