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Capitalization versus Expensing

Gloria Hernandez is the controller of a public company. She just completed a meeting with her superior, John Harrison, who is the CFO of the company. Harrison tried to convince Hernandez to go along with his proposal to combine 12 expenditures for repair and maintenance of a plant asset into one amount ($1 million). Each of the expenditure is less than $100,000, the cutoff point for the capiutalizing expenditures as an asset and depreciating it over the useful life. Hernandez asked for time to think about the matter. As the controller and chief accounting officer of the company, Hernandez knew it's her responsibility to decide how to record the expenditures. She knows that the 1 million amount is material to earnings and the rules in accounting require expensing of each individual item, not capitalization. However, she is under a great deal of pressure to go along with capitalization to boost earnings and meet financial analyst's earnings expectations, and provide for a bonus to top management including herself. Her job may be at stake, and she doesn't want to disappoint her boss.

Question

Assume both Hernandez and Harrison hold the CPA and CMA designations

1. What are the loyalty obligations of both parties in this case?

2. Assume that you are in Gloria Hernandez's position, what will motivate you to speak up and act to or to stay silent? Would it make a different if Harrison promised this was a one time request?

3What would you do and why?

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