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Internal controls: manager's control over her compensation

Kelly Steinman is the manager of a medium size company. A few years ago, Steinman persuaded the owner to base a part of her compensation on the net income the company earns each year. Each December she estimates year-end financial figures in anticipation of the bonus she will receive. If the bonus is not as high as she would like, she offers several recommendations to the accountant for the year-end adjustments. One of her favorite recommendations is for the controller to reduce the estimate of doubtful accounts.

a. What effect does lowering the estimate for doubtful accounts have on the income statement and balance sheet?

b. Do you think Steinman's recommendation to adjust the allowance for Doubtful accounts is within her right as a manager, or do you think this action is an ethics violation? Justify your response.

c. What type of internal control (s) might be useful for this company in overseeing the manager's recommendations for accounting changes

Solution Preview

Lowering the total in the allowance account would increase total assets and increase net income. The effect to the balance sheet is zero because while profits (and therefore retained earnings) are more, assets are increased by the same amount. Think through the entry in this case (which is backwards from the normal entry): debit allowance and credit expense.

There is an ...

Solution Summary

The solution explains the basic problem which allows a manager to effect her own compensation and shifts the responsibility to where it belongs.

Two solutions are suggested. Either or both will cure the ethical problem.

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