Cranor Corp Ethics Case

Accounting Ethics Case

     In this case we are presented with an ethical dilemma at Cranor Corporation, a medical equipment manufacturer. Cranor Co. has sustained an $8.4 million before tax loss, primarily due to $10 million in expenses related to a product recall. The recall was attributed to a design flaw in Cranor’s new line of machines, which is not uncommon for the industry; however, there has never been a recall of this magnitude in company history. The company controller suggests that the loss be included on the income statement as an extraordinary item which in turn would show an increase in income from continuing operations from the prior year.

     Here in lies the ethical issue. An extraordinary item, by definition, must be both unusual in nature and infrequent in occurrence. Although product recalls may be infrequent, they are known to happen in this industry and have occurred at Cranor in the past. The controller wants to preserve Cranor’s decade of consistent income growth. Additionally, the controller along with the rest of Cranor’s employees would personally benefit since their bonuses are tied to income from continuing operations rather than net income. This affects Cranor’s stakeholders; that is the investors, the employees, and the stock market. By classifying the loss as an extraordinary item, Cranor would be misrepresenting their books and misleading the stock market and their investors into believing they have continued their growth streak and have remained profitable, when in fact they suffered an $8.4 million before tax loss. Another issue this brings up is with the employees and their bonuses. Since the employee bonuses are linked to income from continued operations rather than net income, they have further incentive to wrongfully classify the loss for a personal gain.

     There are certainly some questions of value and moral judgment that are related to this situation. It is considered by many immoral to mislead external users and to misrepresent the financial performance of an organization. To justify this as an extraordinary item by claiming a recall of this magnitude has never occurred and that the design flaw has since been corrected and quality control procedures have been upgraded shows poor judgment. It is the right of the external users as stated in the full disclosure principle to be made aware of any and all information that may influence their decisions. It is also highly unethical to distort financial statements for personal gain in form of employee bonus.

     As an alternative to showing the expense from the recall as an extraordinary item, Cranor Co. could have the loss on their income statement as an expense in continued operations. They can include a note in the statement to clarify the loss was due to a design flaw in manufacturing that has since been corrected and overall quality control procedures have been upgraded to avoid similar losses going forward. Although Cranor’s decade streak of income growth would come to an end, this would be a more honest approach than falsely showing continued growth and profitability. Cranor Co. is responsible and at fault for the design flaw and as such must report the consequences of the error. It is only what is right if other companies in the industry would report a recall the same way.