There are financial reporting and ethical issues present in what the CEO has asked of his
accountant.
If this had been me that the CEO had approached, I would have looked at the books and
verified the dates that construction started as well as any costs that may have been incurred in
the previous year. I would then tell the CEO that because the construction did not start until
June 2016, there is no interest that can be capitalized in 2015. The GAAP approach is as
follows: 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 (Wahlen, et al., 2017). In this case, there was only planning with the architect in
the works in 2015. It is unclear if there were actually costs incurred from the architect, but in
any case, that only means that one of the three conditions have been met to capitalize interest
from 2015 into 2016. The request for me to add lots of overhead to the cost of the building to
increase profits is not a good idea either. This makes the financial reporting not
representationally faithful. This is because to be comparable, the allocation of overhead to
normal operations should not change because the overhead would have been incurred whether
the construction takes place (Wahlen, et al., 2017). The CEO is in a sense asking me to fudge
the numbers and make the financials look better, when this is not an appropriate
representation of the actual financial position of the company. The job of me, the accountant,
is to produce the financials of the company ethically and accurately, no matter how good or
bad it makes the company look. What the CEO is asking for is unethical and could be
detrimental to the financial reports that shareholders review. Making the financials look better
not only makes me look bad, but it brings my own morals into question, makes me go against
the principles of GAAP, and also makes me wonder who I am working for and why he would
want to be dishonest.
First of all, I want to state that if I am the accountant at this company, I really need to
reevaluate my position and personally reflect whether my hard work to obtain my degree
justifies me working for this CEO. If the CEO has this type of thinking in this particular
“secluded” situation, what else will he/she be asking me to do in the future that is unethical
and doesn’t abide by GAAP standards. d There are major issues and concerns from a financial
reporting perspective when a CEO is trying to add lots of overhead to the cost of the building
to increase profit for that year is unethical. d When the suggestion is made to add 1/12 of your
salary to cost of the building, raises red flags. There are certain things that can be added which
are fixed overhead and variable overhead to self-constructed assets. This type of asset is built
by the company, and they appear on the balance sheet. The cost included in self-constructed
assets are direct cost such as materials and labour that are strictly associated with the
construction. The total assets would have to exceed the fair value and be recorded at fair
value. d The question concerning the building and when the actual construction started, which
was in 2016, does not allow for 2015 preplanning to be capitalized as interest in year 2015.
The rules of GAAP tell us that the interest can be capitalized on from June 2016 when
construction started. Interest is added to the cost of the long-term asset, so preplanning is not
recognized in the current period as an interest expense. Moving forward it is a fixed asset and
is included in the depreciation of the long-term asset. Even though it initially appears on the
balance sheet and is charged as an expense over the useful life of the asset; the expenditure
should appear on the income statement as depreciation expense and not an interest expense
(Accounting Tools 2019) If I was to report the financial statement based on the CEOs
recommendations, I would not be abiding by the GAAP and risking my job later.
If I were the accountant of this company, I must tell the CEO that this is a violation and
unethical. As a CEO, he should know some basic knowledge of business or financial
principles. As accountants, we have a professional responsibility to report any financial
information accurately and transparently by following the GAAP. I am not able to capitalize
on the interest for 2015 of this construction because it was started around June 2016.
According to the book, “there is nothing to capitalize until expenses are actually incurred”
(Wahlen et al., 2017). Even though the planning of construction was started in 2015, there is
no interest in this construction to capitalize in 2015.
Adding lots of overhead and adding my partial salary to the cost of the building is unethical
and illegal unless there are some costs that were not recorded or reported before.
After reading what the CEO has asked me to do I have several issues that i would need to
bring up. Firstly, he asks to capitalize on interest from the 2015 period which only included
planning. Interest cannot begin to capitalize until building has begun, which is not until 2016.
For capitalization, we need expenditures for assets to have started, any processes to get the
asset ready for its use to have begun, and incurred interest cost all must be happening in order
to capitalize on interest. If one of these three things is not happening in accordance with
GAAP we cannot capitalize on interest. This seems to be unethical and illegal to lie about
when things began to happen.
As for when the CEO asks to include extra costs into the overhead, he is trying to make the
business look more profitable based on false information. This is illegal to add false costs to
anything to make it look like your business is more successful, it misleads investors and
companies who would offer you loans. It seems the CEO does not care about ethics and will
more than likely bring his business and employees down with him. I would not wish to work
for someone who has no regard for the law or others.
If approached by the CEO, I would explain to him that what he is asking is unethical and not
in accordance with GAAP principles. d I would advise that I am unable to do what he is asking
and I would explain to him why it cannot be done. I would explain that according to GAAP,
to capitalize interest a company must address three issues:
Does the asset qualify for interest capitalization? d A company is required to capitalize interest
on assets that are either constructed for its own use or constructed as discrete projects for sale
or lease to others. In addition, if a company purchases land and incurs expenditures to
develop it for a particular use (e.g., a building or plant site), any interest costs that are
associated with these expenditures qualify for interest capitalization and are included as part
of the cost of the resulting asset, not the land (Wahlen, 2017).
Over what period can interest be capitalized? 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 (Wahlen, 2017).
Over what period can interest be capitalized? 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 (Wahlen, 2017).
Since construction did not begin until 2016, interest cannot be capitalized for 2015. Planning
completed in 2015 does not qualify for capitalization because it does meet the conditions
required. It is also not possible to "double dose" on capitalization for 2016 as the interest is
capitalized by the actual interest on incremental funds borrowed for the construction.
I would also advise there are two alternatives for a company to include overhead costs in the
cost of a self-constructed asset. I would explain the company can allocate fixed and variable
overhead to the self-constructed asset in the same manner it allocates overhead to units of
inventory produced. I would explain the company can only include the overhead that
increases as a result of the construction. I would explain that it would be unfaithful
representation to include a portion of my salary to the cost of the construction since no
additional cost is being incurred. d I advised that my salary would have been incurred whether
the construction took place or not, therefore, it would not be ethical to report it again
(Wahlen, 2017).
Reference:
Wahlen, James M., et al. Intermediate Accounting: Reporting and Analysis. Cengage
Learning, 2017.
Wahlen, Jones & Pagach. (2017). Intermediate Accounting: Reporting and analysis (2nd ed.).
Boston, MA: Cengage Learning.
Wahlen, James M., et al. Intermediate Accounting: Reporting and Analysis. Cengage
Learning, 2017.
