Ethical Obligations

Business

Quiz 2 :

Cognitive Processes and Ethical Decision Making in Accounting

Quiz 2 :

Cognitive Processes and Ethical Decision Making in Accounting

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The following story applies to questions 1 and 2: On October 15, 2009, in Fort Collins, Colorado, the parents of a six-year-old boy, Falcon Henne, claimed that he had floated away in a homemade helium balloon that was shaped to resemble a silver flying saucer. Some in the media referred to the incident as "Balloon Boy." The authorities had closed down Denver International Airport, called in the National Guard, and a police pursuit ensued. After an hour-long flight that covered more than 50 miles across three counties, the empty balloon was found near the airport. It was later determined that the boy was hiding in the house all along in an incident that was a hoax and motivated by publicity that might lead to a reality television show. The authorities blamed the father, Richard, for the incident and decided to prosecute him. Richard Heene pleaded guilty on November 13, 2009, to the felony count of falsely influencing authorities. He pled to protect his wife, Mayumi, a Japanese citizen, who he believed may have been deported if Richard was convicted of a more serious crime. Richard also agreed to pay $36,000 in restitution. Identify the stakeholders and how they were affected by Heene's actions using ethical reasoning.
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The stakeholders in this case are the government, and the parents. The government, national guards, airports, and police spent considerable effort to find a boy that turned out not to be missing. This effort could have been spent on actual events. The parents have a stake in the publicity of their stunt.

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Better Boston Beans Better Boston Beans is a coffee shop located in the Faneuil Hall Marketplace near the waterfront and Government Center in Boston. It specializes in exotic blends of coffee, including Sumatra Dark Roast Black, India Mysore "Gold Nuggets," and Guatemala Antigua. It also serves a number of blended coffees, including Reggae Blend, Jamaican Blue Mountain Blend, and Marrakesh Blend. For those with more pedestrian tastes, the shop serves French Vanilla, Hazelnut, and Hawaiian Macadamia Nut varieties. The coffee of the day varies, but the most popular is Colombia Supremo. The coffee shop also serves a variety of cold-blended coffees. Cindie Rosen has worked for Better Boston Beans for six months. She took the job right out of college because she wasn't sure whether she wanted to go to graduate school before beginning a career in financial services. Cindie hoped that by taking a year off before starting her career or going on to graduate school, she would experience "the real world" and find out firsthand what it is like to work a 40-hour week. (She did not have a full-time job during her college years because her parents helped pay for the tuition.) Because Cindie is the "new kid on the block," she is often asked to work the late shift, from 4 p.m. to midnight. She works with one other person, Jeffrey Lyndell, who is the assistant shift supervisor. Lyndell has been with Boston Beans for three years but recently was demoted from shift supervisor. For the past two weeks, Lyndell has been leaving before 11 p.m., after most of the stores in the Marketplace close, and he has asked Cindie to close up by herself. Cindie feels that this is wrong and it is starting to concern her, but she hasn't spoken to Lyndell and has not informed the store manager either. However, something happened one night that is causing Cindie to consider taking the next step. At 11 p.m., 10 Japanese tourists came into the store for coffee. Cindie was alone and had to rush around and make five different cold-blended drinks and five different hot- blended coffees. While she was working, one of the Japanese tourists, who spoke English very well, approached her and said that he was shocked that such a famous American coffee shop would only have one worker in the store at any time during the workday. Cindie didn't want to ignore the man's comments, so she answered that her coworker had to go home early because he was sick. That seemed to satisfy the tourist. It took Cindie almost 20 minutes to make all the drinks and also field two phone calls that came in during that time. After she closed for the night, Cindie reflected on the experience. She realized that it could get worse before it gets better because Lyndell was now making it a habit to leave work early. At this point, she realizes that she has to either approach Lyndell about it or speak with the store manager. She feels much more comfortable talking to the store manager. In fact, in Cindie's own words, "Lyndell gives me the creeps." Questions 1. Consider Kohlberg's six stages of moral development. What would Cindie do and why if she reasoned at each of the six stages? 2. Assume that Cindie approached Lyndell about her concerns. Lyndell tells Cindie that he has an alcohol problem. Lately, it's gotten to him real bad. That's why he's left early-to get a drink and calm his nerves. Lyndell also said that this is the real reason he was demoted. He had been warned that if one more incident occurred, the store manager would fire him. He pleaded with Cindie to work with him through these hard times. How would you react to Lyndell's request if you were Cindie? Would you honor his request for confidentiality and support? Why or why not? What if Lyndell was a close personal friend-would that change your answer? Be sure to consider the implications of your decision on other parties potentially affected by your actions. 3. Assume that Cindie keeps quiet. The following week, another incident occurred: Cindie got into a shouting match with a customer who became tired of waiting for his coffee after 10 minutes. Cindie felt terrible about it, apologized to the customer after serving his coffee, and left work that night wondering if it was time to apply to graduate school. The customer was so irate that he contacted the store manager and expressed his displeasure about both the service and Cindie's attitude. What do you think the store manager should do? Support your answer with ethical reasoning.
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1. The Kohlberg's moral development stages are listed below. Preconventional:
• Stage 1: Obedience and punishment - morals are followed to avoid punishment
• Stage 2: Self-interest - morals are pursued if there's a benefit. Conventional:
• Stage 3: Norms - one considers how others may perceive their actions.
• Stage 4: Social order - morals need to be followed to maintain order in society
Postconventional:
• Stage 5: Social contract - considers the overall cost benefit to society.
• Stage 6: Universal ethics - absolute notion of following ethics
At the preconventional level, C may have an obligation to report to her store manager that her supervisor was taking home early. The store is paying additional wage for less work. It's also in C's best interest to have someone work late with her to serve customers or close up as late shifts can be dangerous. At the conventional level, C's supervisor may be disappointed in her. But by not reporting his behavior she's working neglecting her duty to her company and letting bad behavior slip. At the postconventional level, C needs to realize that it's unethical to take early leave and just report it. 2. C's supervisor has a drinking problem. It will not go away if he continues drinking. The company had not fired him but only demoted him. She should advise him to be upfront to the company with the problem. In the long run the supervisor is better off by working on his alcoholism. A really good friend would want to see him be a better person. 3. The store manager should approach both C and her supervisor. She needs to find out all the facts of the case from them, then determine the best course of action. C will need to be reprimanded for not reporting her supervisor, but given that she worked diligently she shouldn't be fired. The supervisor on the other hand is unreliable. But an ethical treatment would be to work with the supervisor to treat his alcoholism.

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Blues Brothers Assume that it is December 31, the last day of the fiscal year, and you are an internal accountant for Saturday Night Accessories, a privately owned company run by the Blues Brothers, that provides personal services to consumers. On that date, a $1.2 million major contract for one year of future services is received. You are instructed by your supervisor who reports to the "Brothers" to record the full amount of the $1.2 million as revenue on December 31. You know that management will receive a bonus for the boosted revenue and you will receive recognition in an upcoming performance review. Questions 1. What is the proper way to account for the revenue in this case? Why? 2. How might you go about convincing your supervisor of the proper accounting? That is, what factors might enable you to get your point across, and what are disablers that might prevent you from achieving that result? 3. Under what circumstances might you consider going to the "Brothers" to discuss the matter?
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The following summarizes the events in the case:
• The manager is asking the accountant to list $1.2 million as earned revenue.
• $1.2 million is unearned revenue, services to be rendered over the year.
• Manager believes this will improve their job prospects, and they will receive bonus. 1. Unearned revenue is revenue that is paid for future services. The $1.2 million is not yet "earned" because the company had not rendered service. Unearned revenue cannot be listed as revenue on income statement until the service has been rendered, e.g. $1.2 million will appear as revenue on the next year. On a balance sheet the company should list prepaid service $1.2 million as liability, with $1.2 million as cash received for it in assets. 2. The accountant should convince the manager to document unearned revenue properly. By inflating the numbers now they receive a bonus and commendation. However, this $1.2 million will not appear in the next year. This will make their department looks like it have a loss in revenue in the next year. The accountant may have a threat to her job if the manager insist on listing the revenue improperly. He may also give her a harder time at work. She may also be discouraged if the firm doesn't practice ethical management. 3. The accountant she go to the bosses for discussion if the manager is not convinced and insist on doing the wrong thing. She may be encouraged to do so if the bosses have an open door policy and fair management practices.

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Supreme Designs, Inc. Supreme Designs, Inc., is a small manufacturing company located in Detroit, Michigan. The company has three stockholders-Gary Hoffman, Ed Webber, and John Sullivan. Hoffman manages the business, including the responsibility for the financial statements. Webber and Sullivan do most of the sales work, and they cultivate potential customers for Supreme Designs. Hoffman recently hired his daughter, Janet, to manage the office. Janet has successfully managed a small clothing boutique in downtown Detroit for the past eight years. She sold the shop to a regional department store that wanted to expand its operations. Gary Hoffman hopes that his daughter will take over as an owner in a few years when he reaches retirement age. Webber and Sullivan are significantly younger than Gary Hoffman. Janet is given complete control over the payroll, and she approves disbursements, signs checks, and reconciles the general ledger cash account to the bank statement balance. Previously, the bookkeeper was the only employee with such authority. However, the bookkeeper recently left the company, and Hoffman needed someone whom he could trust to be in charge of these sensitive operations. He did ask his daughter to hire someone as soon as possible to help with these and other accounting functions. Janet hired Kevin Greenberg shortly thereafter, based on a friend's recommendation. Greenberg is a relatively inexperienced accountant, but he was willing to work for less than what the company had paid the former bookkeeper. On April 29, 2013, about one year after hiring Greenberg, Janet discovers that she needs surgery. Even though the procedure is fairly common and the risks are minimal, she plans on spending five weeks in recovery because of related medical problems that could flare up if she returns to work too soon. She tells Greenberg to approve vouchers for payment and present them to her father during this time, and her father will write the checks during her absence. Janet had previously discussed this plan with her father, and they both agreed that Greenberg was ready to assume the additional responsibilities. They did not, however, discuss the matter with either Webber or Sullivan. The bank statement for April arrives on May 3, 2013. Janet did not tell Greenberg to reconcile the bank statements. In fact, she specifically told him to just put those aside until her return. However, Greenberg decides to reconcile the April bank statement as a favor to Janet and to lighten her workload after she returns. Although everything appears to be in order, Greenberg is not sure what to make of his finding that Janet approved and signed five checks payable to herself, each for the same amount, during April 2013. Each check appears in correct numerical sequence, 1 check of every 10 checks written during the month. Greenberg was surprised because if these were payroll checks (as he had suspected because they were for the same amount), it was highly unusual. This is because the payroll is processed once a month for all employees of Supreme Designs. In fact, he found only one canceled check for each of the other employees, including himself. Curiosity gets the better of Greenberg, and he decides to trace the checks paid to Janet to the cash disbursements journal. He looked for supporting documentation but couldn't find any. He noticed that four of the five checks were coded to different accounts: one each to supplies, travel and entertainment, and books and magazines, and two to miscellaneous expenses. After considering what his findings might mean and whether he should contact Janet, Greenberg decided to expand his search. He reviewed the bank statements for January through March 2013. In all, there were 15 additional checks made payable to Janet, each for the same amount as the 5 in April. These 20 checks totaled $30,000. Greenberg still thought it was possible that these amounts represented Janet's salary because he knows that her annual salary is $50,000. Perhaps she took out a little more this year. Greenberg doesn't know what to do. He could contact Janet, but he knows that she would be unhappy that he opened the bank statements and went so far as to reconcile cash for April even though she specifically told him not to. Perhaps he should contact the three stockholders. Then again, it may be best to keep quiet about the entire matter. Questions 1. Do you think Greenberg did the "right" thing by opening the April bank statement and reconciling it to the general ledger? Why or why not? What about the previous bank statements? 2. Explain what Greenberg should do if he reasons at each of the six stages of Kohlberg's model of moral development. Be sure to consider stakeholder effects in your answer. 3. Evaluate what steps should be taken in each of the following independent situations: a. If you were Janet and Greenberg dropped by the hospital to tell you about his discovery, how would you react? b. Assume that Greenberg contacts Janet's father because he did not want to upset her after the surgery. Hoffman talks to his daughter, who informs him that she had a shortage in her personal funds and planned to repay the $30,000 after she returns. What would you do if you were Gary Hoffman? Why? c. Assume that Hoffman does nothing because of his daughter's explanation. Janet returns to work and fires Kevin Greenberg. What would you do if you were Greenberg? Why? How do you think his action (or inaction) might affect his opportunity for other jobs? Should that matter in terms of what he decides to do?
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The following story applies to questions 1 and 2: On October 15, 2009, in Fort Collins, Colorado, the parents of a six-year-old boy, Falcon Henne, claimed that he had floated away in a homemade helium balloon that was shaped to resemble a silver flying saucer. Some in the media referred to the incident as "Balloon Boy." The authorities had closed down Denver International Airport, called in the National Guard, and a police pursuit ensued. After an hour-long flight that covered more than 50 miles across three counties, the empty balloon was found near the airport. It was later determined that the boy was hiding in the house all along in an incident that was a hoax and motivated by publicity that might lead to a reality television show. The authorities blamed the father, Richard, for the incident and decided to prosecute him. Richard Heene pleaded guilty on November 13, 2009, to the felony count of falsely influencing authorities. He pled to protect his wife, Mayumi, a Japanese citizen, who he believed may have been deported if Richard was convicted of a more serious crime. Richard also agreed to pay $36,000 in restitution. What stage of moral reasoning in Kohlberg's model is exhibited by Richard Heene's actions? Do you believe the punishment fit the crime? In other words, was justice done in this case? Why or why not?
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WorldCom The WorldCom fraud was the largest in U.S. history, surpassing even that of Enron. Beginning modestly during mid-year 1999 and continuing at an accelerated pace through May 2002, the company, under the direction of Bernie Ebbers, the CEO, Scott Sullivan, the CFO, David Myers, the controller, and Buford Yates, the director of accounting, "cooked the books" to the tune of about $11 billion of misstated earnings. Investors collectively lost $30 billion as a result of the fraud. The fraud was accomplished primarily in two ways: 1. Booking "line costs" for interconnectivity with other telecommunications companies as capital expenditures rather than operating expenses; 2. Inflating revenues with bogus accounting entries from "corporate unallocated revenue accounts." During 2002, Cynthia Cooper, the vice president of internal auditing, responded to a tip about improper accounting by having her team do an exhaustive hunt for the improperly recorded line costs that were also known as "prepaid capacity." That name was designed to mask the true nature of the costs and treat them as capitalizable costs rather than as operating expenses. The team worked tirelessly, often at night and secretly, to investigate and reveal $3.8 billion worth of fraud. Soon thereafter, Cooper notified the company's audit committee and board of directors of the fraud. The initial response was not to take action, but to look for explanations from Sullivan. Over time, Cooper realized that she needed to be persistent and not give in to pressure that Sullivan was putting on her to back off. Cooper even approached KPMG, the auditors that had replaced Arthur Andersen, to support her in the matter. Ultimately, Sullivan was dismissed, Myers resigned, Andersen withdrew its audit opinion for 2001, and the Securities and Exchange Commission (SEC) began an investigation into the fraud on June 26, 2002. In an interview with David Katz and Julia Homer for CFO Magazine on February 1, 2008, Cynthia Cooper was asked about her whistleblower role in the WorldCom fraud. When asked when she first suspected something was amiss, Cooper said: "It was a process. My feelings changed from curiosity to discomfort to suspicion based on some of the accounting entries my team and I had identified, and also on the odd reactions I was getting from some of the finance executives." 1 Cooper did exactly what is expected of a good auditor. She approached the investigation of line-cost accounting with a healthy dose of skepticism and maintained her integrity throughout, even as Sullivan was trying to bully her into dropping the investigation. When asked whether there was anything about the culture of WorldCom that contributed to the scandal, Cooper laid blame on Bernie Ebbers for his risk-taking approach that led to loading up the company with $40 billion in debt to fund one acquisition after another. He followed the same reckless strategy with his own investments, taking out loans and using his WorldCom stock as collateral. Cooper believed that Ebbers's personal decisions then affected his business decisions; he ultimately saw his net worth disappear, and he was left owing WorldCom some $400 million for loans approved by the board. Ebbers was sentenced to 25 years in jail for his offenses. Betty Vinson, the company's former director of corporate reporting, was one of five former WorldCom executives who pleaded guilty to fraud. At the trial of Ebbers, Vinson said she was told to make improper accounting entries because Ebbers did not want to disappoint Wall Street. "I felt like if I didn't make the entries, I wouldn't be working there," Vinson testified. She said that she even drafted a resignation letter in 2000, but ultimately she stayed with the company. Vinson said that she took her concerns to Sullivan, who told her that Ebbers did not want to lower Wall Street expectations. Asked how she chose which accounts to alter, Vinson testified: "I just really pulled some out of the air. I used some spreadsheets." 2 Her lawyer had urged the judge to sentence Vinson to probation, citing the pressure placed on her by Ebbers and Sullivan. "She expressed her concern about what she was being directed to do to upper management, and to Sullivan and Ebbers, who assured her and lulled her into believing that all was well," he said. In the end, Vinson was sentenced to five months in prison and five months of house arrest. Questions 1. What is the difference between accrual earnings and cash earnings? In addition to the effect on accrual earnings of capitalizing the line costs, how might the treatment mask the true nature of operating cash flows? 2. Identify the stakeholders in the WorldCom case and how their interests were affected by the financial fraud. 3. Use ethical reasoning to compare the actions of Cynthia Cooper in the WorldCom case to those of Sherron Watkins in the Enron case, discussed earlier in this chapter. 1 David K. Katz and Julia Homer, "WorldCom Whistle-blower Cynthia Cooper," CFO Magazine, February 1, 2008. Available at: www.cfo.com/article.cfm/10590507. 2 Susan Pulliam, "Ordered to Commit Fraud, a Staffer Balked, Then Caved: Accountant Betty Vinson Helped Cook the Books at WorldCom," The Wall Street Journal, June 23, 2003. Available at www.people.tamu.edu/~jstrawser/acct229h/Current%20Readings/E.%20WSJ.com%20-%20A%20Staffer%20 0rdered%20to%20Commit%20Fraud,%20Balked.pdf.
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The following story applies to questions 1 and 2: On October 15, 2009, in Fort Collins, Colorado, the parents of a six-year-old boy, Falcon Henne, claimed that he had floated away in a homemade helium balloon that was shaped to resemble a silver flying saucer. Some in the media referred to the incident as "Balloon Boy." The authorities had closed down Denver International Airport, called in the National Guard, and a police pursuit ensued. After an hour-long flight that covered more than 50 miles across three counties, the empty balloon was found near the airport. It was later determined that the boy was hiding in the house all along in an incident that was a hoax and motivated by publicity that might lead to a reality television show. The authorities blamed the father, Richard, for the incident and decided to prosecute him. Richard Heene pleaded guilty on November 13, 2009, to the felony count of falsely influencing authorities. He pled to protect his wife, Mayumi, a Japanese citizen, who he believed may have been deported if Richard was convicted of a more serious crime. Richard also agreed to pay $36,000 in restitution. Arthur Andersen LLP was the auditor for Enron, WorldCom, Waste Management, and other companies that committed fraud. Andersen was forced to shut its doors forever after a U.S. Department of Justice lawsuit against it concluded that it had obstructed justice and lied to the government in the Enron case. One thing Andersen had done was to shred documents related to its audit of Enron before the government could get its hands on them. Some in the profession thought that the government had gone too far given the facts and mediating circumstances (including top management's deception); others believed that the punishment was unjustified because most accounting firms got caught up in similar situations during the late 1990s and early 2000s (pre-Sarbanes-Oxley). What do you believe? Use ethical reasoning to support your answer.
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Milton Manufacturing Company Milton Manufacturing Company produces a variety of textiles for distribution to wholesale manufacturers of clothing products. The company's primary operations are located in Long Island City, New York, with branch factories and warehouses in several surrounding cities. Milton Manufacturing is a closely held company, and Irv Milton is the president. He started the business in 2002, and it grew in revenue from $500,000 to $5 million in 10 years. However, the revenues declined to $4.5 million in 2012. Net cash flows from all activities also were declining. The company was concerned because it planned to borrow $20 million from the credit markets in the fourth quarter of 2013. Irv Milton met with Ann Plotkin, the chief accounting officer (CAO), on January 15, 2013, to discuss a proposal by Plotkin to control cash outflows. She was not overly concerned about the recent decline in net cash flows from operating activities because these amounts were expected to increase in 2013 as a result of projected higher levels of revenue and cash collections. Plotkin knew that if overall capital expenditures continued to increase at the rate of 26 percent per year, Milton Manufacturing probably would not be able to borrow the $20 million. Therefore, she suggested establishing a new policy to be instituted on a temporary basis. Each plant's capital expenditures for 2013 would be limited to the level of capital expenditures in 2011. Irv Milton pointedly asked Plotkin about the possible negative effects of such a policy, but in the end, he was convinced that it was necessary to initiate the policy immediately to stem the tide of increases in capital expenditures. A summary of cash flows appears in Exhibit 1. Sammie Markowicz is the plant manager at the headquarters in Long Island City. He was informed of the new capital expenditure policy by Ira Sugofsky, the vice president for operations. Markowicz told Sugofsky that the new policy could negatively affect plant operations because certain machinery and equipment, essential to the production process, had been breaking down more frequently during the past two years. The problem was primarily with the motors. New and better models with more efficient motors had been developed by an overseas supplier. These were expected to be available by April 2013. Markowicz planned to order 1,000 of these new motors for the Long Island City operation, and he expected that other plant managers would do the same. Sugofsky told Markowicz to delay the acquisition of new motors for one year, after which time the restrictive capital expenditure policy would be lifted. Markowicz reluctantly agreed. Milton Manufacturing operated profitably during the first six months of 2013. Net cash inflows from investing activities exceeded outflows by $250,000 during this time period. It was the first time in three years that there was a positive cash flow from investing activities. Production operations accelerated during the third quarter as a result of increased demand for Milton's textiles. An aggressive advertising campaign initiated in late 2012 seemed to bear fruit for the company. Unfortunately, the increased level of production put pressure on the machines, and the degree of breakdown was increasing. A big problem was that the motors wore out prematurely. Markowicz was concerned about the machine breakdown and increasing delays in meeting customer demands for the shipment of the textile products. He met with the other branch plant managers, who complained bitterly to him about not being able to spend the money to acquire new motors. Markowicz was very sensitive to their needs. He informed them that the company's regular supplier had recently announced a 25 percent price increase for the motors. Other suppliers followed suit, and Markowicz saw no choice but to buy the motors from the overseas supplier. That supplier's price was lower, and the quality of the motors would significantly enhance the machines' operating efficiency. However, the company's restrictions on capital expenditures stood in the way of making the purchase. Markowicz approached Sugofsky and told him about the machine breakdowns and the concerns of other plant managers. Sugofsky seemed indifferent. He reminded Markowicz of the capital expenditure restrictions in place and that the Long Island City plant was committed to keep expenditures at the same level as it had in 2011. Markowicz argued that he was faced with an unusual situation and he had to act now. Sugofsky hurriedly left, but not before he said to Markowicz: "A policy is a policy." Markowicz reflected on the comment and his obligations to Milton Manufacturing. He was conflicted because he viewed his primary responsibility and that of the other plant managers to ensure that the production process operated smoothly. The last thing the workers needed right now was a stoppage of production because of machine failure. At this time, Markowicz learned of a 30-day promotional price offered by the overseas supplier to gain new customers by lowering the price for all motors by 25 percent. Coupled with the 25 percent increase in price by the company's supplier, Markowicz knew he could save the company $1,500, or 50 percent of cost, on each motor purchased from the overseas supplier. After carefully considering the implications of his intended action, Markowicz contacted the other plant managers and informed them that while they were not obligated to follow his lead because of the capital expenditure policy, he planned to purchase 1,000 motors from the overseas supplier for the headquarters plant in Long Island City. Markowicz made the purchase in the fourth quarter of 2013 without informing Sugofsky. He convinced the plant accountant to record the $1.5 million expenditure as an operating (not capital) expenditure because he knew that the higher level of operating cash inflows would mask the effect of his expenditure. In fact, Markowicz was proud that he had "saved" the company $1.5 million, and he did what was necessary to ensure that the Long Island City plant continued to operate. The acquisitions by Markowicz and the other plant managers enabled the company to keep up with the growing demand for textiles, and the company finished the year with record high levels of net cash inflows from all activities. Markowicz was lauded by his team for his leadership. The company successfully executed a loan agreement with Second Bankers Hours Trust Co. The $20 million borrowed was received on January 3, 2014. During the course of an internal audit on January 21, 2014, Beverly Wald, the chief internal auditor (and also a CPA), discovered that there was an unusually high number of motors in inventory. A complete check of the inventory determined that $1 million worth of motors remained on hand. Wald reported her findings to Ann Plotkin, and together they went to see Irv Milton. After being informed of the situation, Milton called in Sugofsky. When Wald told him about her findings, Sugofsky's face turned beet red. He paced the floor, poured a glass of water, drank it quickly, and then began his explanation. Sugofsky told them about his encounter with Markowicz. Sugofsky stated in no uncertain terms that he had told Markowicz not to increase plant expenditures beyond the 2011 level. "I left the meeting believing that he understood the company's policy. I knew nothing about the purchase," he stated. At this point, Wald joined in and explained to Sugofsky that the $1 million is accounted for as inventory, not as an operating cash outflow: "What we do in this case is transfer the motors out of inventory and into the machinery account once they are placed into operation because, according to the documentation, the motors added significant value to the asset." Sugofsky had a perplexed look on his face. Finally, Irv Milton took control of the accounting lesson by asking: "What's the difference? Isn't the main issue that Markowicz did not follow company policy?" The three officers in the room shook their head simultaneously, perhaps in gratitude for being saved the additional lecturing. Milton then said he wanted the three of them to brainstorm some alternatives on how best to deal with the Markowicz situation and present the choices to him in one week. Questions Use the Integrated Ethical Decision-Making Process explained in this chapter to help you assess the following: 1. Identify the ethical and professional issues of concern to Beverly Wald in this case. 2. Identify and evaluate the alternative courses of action for Wald, Plotkin, and Sugofsky to present in their meeting with Milton. 3. How do virtue considerations influence the alternatives presented? 4. If you were in Milton's place, which of the alternatives would you choose and why?
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The following story applies to questions 1 and 2: On October 15, 2009, in Fort Collins, Colorado, the parents of a six-year-old boy, Falcon Henne, claimed that he had floated away in a homemade helium balloon that was shaped to resemble a silver flying saucer. Some in the media referred to the incident as "Balloon Boy." The authorities had closed down Denver International Airport, called in the National Guard, and a police pursuit ensued. After an hour-long flight that covered more than 50 miles across three counties, the empty balloon was found near the airport. It was later determined that the boy was hiding in the house all along in an incident that was a hoax and motivated by publicity that might lead to a reality television show. The authorities blamed the father, Richard, for the incident and decided to prosecute him. Richard Heene pleaded guilty on November 13, 2009, to the felony count of falsely influencing authorities. He pled to protect his wife, Mayumi, a Japanese citizen, who he believed may have been deported if Richard was convicted of a more serious crime. Richard also agreed to pay $36,000 in restitution. Aristotle believed that there was a definite relationship between having practical wisdom (i.e., knowledge or understanding that enables one to do the right thing) and having moral virtue, but these were not the same thing. Explain why. How do these virtues interact in Rest's Four- Component Model of Ethical Decision Making?
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Juggyfroot "I'm sorry, Lucy. That's the way it is," Ricardo Rikey said. "I just don't know if I can go along with it, Rikey," Lucy replied. "We have no choice. Juggyfroot is our biggest client, Lucy. They've warned us that they will put the engagement up for bid if we refuse to go along with the reclassification of marketable securities," Rikey explained. "Have you spoken to Fred and Ethel about this?" Lucy asked. "Are you kidding? They're the ones who made the decision to go along with Juggyfroot," Rikey responded. The previous scene took place in the office of Deziloo LLP, a large CPA firm in Beverly Hills, California. Lucy Spheroid is the partner on the engagement of Juggyfroot, a publicly owned global manufacturer of pots and pans and other household items. Ricardo Rikey is the managing partner of the office. Fred and Ethel are the two members of the firm that make final judgments on difficult accounting issues, especially when there is a difference of opinion with the client. All four are CPAs. Ricardo Rikey is preparing for a meeting with Norman Baitz, the CEO of Juggyfroot. Rikey knows that the company expects to borrow $5 million next quarter and it wants to put the best possible face on its financial statements to impress the banks. That would explain why the company reclassified a $2 million market loss on a trading investment to the available- for-sale category so that the "loss" would now show up in stockholder's equity, not as a charge against current income. The result was to increase earnings in 2013 by 8 percent. Rikey also knows that without the change, the earnings would have declined by 2 percent and the company's stock price would have taken a hit. In the meeting, Rikey points out to Baitz that the investment in question was marketable, and in the past, the company had sold similar investments in less than one year. Rikey adds there is no justification under generally accepted accounting principles (GAAP) to change the classification from trading to available-for-sale. Questions 1. Explain the rules in accounting to determine whether an investment in a marketable security should be accounted for as trading, available-for-sale, or held-to-maturity. Include in your discussion how such classification affects the financial statements. 2. Who are the stakeholders in this case? What expectations should they have, and what are the ethical obligations of Deziloo and its CPAs to the stakeholders? Use ethical reasoning to answer this question. 3. Using the AICPA Code of Professional Conduct as a reference, what ethical issues exist for Rikey, Lucy, Fred, Ethel, and Deziloo LLP in this matter? What role does auditor virtue play in determining what to do in this case?
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The following story applies to questions 1 and 2: On October 15, 2009, in Fort Collins, Colorado, the parents of a six-year-old boy, Falcon Henne, claimed that he had floated away in a homemade helium balloon that was shaped to resemble a silver flying saucer. Some in the media referred to the incident as "Balloon Boy." The authorities had closed down Denver International Airport, called in the National Guard, and a police pursuit ensued. After an hour-long flight that covered more than 50 miles across three counties, the empty balloon was found near the airport. It was later determined that the boy was hiding in the house all along in an incident that was a hoax and motivated by publicity that might lead to a reality television show. The authorities blamed the father, Richard, for the incident and decided to prosecute him. Richard Heene pleaded guilty on November 13, 2009, to the felony count of falsely influencing authorities. He pled to protect his wife, Mayumi, a Japanese citizen, who he believed may have been deported if Richard was convicted of a more serious crime. Richard also agreed to pay $36,000 in restitution. Do you agree with Carol Gilligan's criticism of Kohlberg's model that women reason differently than men and rely more on a care-and-response orientation? Why or why not? Do you believe Kohlberg's model is culturally biased? Why or why not?
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In teaching about moral development, instructors often point out the threefold nature of morality: It depends on emotional development (in the form of the ability to feel guilt or shame), social development (manifested by the recognition of the group and the importance of moral behavior for the group's existence), and cognitive development (especially the ability to adopt another's perspective). How does this perspective of morality relate to ethical reasoning by accountants and auditors?
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Shifty Industries Shifty Industries is a small business that sells home beauty products in the San Luis Obispo, California, area. The company has experienced a cash crunch and is unable to pay its bills on a timely basis. A great deal of pressure exists to minimize cash outflows such as income tax payments to the Internal Revenue Service (IRS) by interpreting income tax regulations as liberally as possible. You are the tax accountant at the company and report to the controller. You are concerned about the fact that the controller approved the income statement shown here for the company at December 31, 2012, for financial reporting purposes. Your concern relates to the accounting treatment of depreciation in light of the IRS Section 179 depreciation regulations displayed in Exhibit 1. The depreciation relates to the purchase of one item of office machinery in 2012 for $40,000. The asset is expected to have a five-year useful life, with no salvage value, and the company uses the straight-line method of depreciation for all office machinery in its financial reports. You reviewed the income statement to help prepare the income tax return for the company that will be filed on April 30, 2013. A special rule known as "expensing" lets small businesses write off the entire cost of certain depreciable assets in the year they are purchased. In other words, you get to treat the cost as a business expense (hence "expensing"), such as salary paid or utilities, rather than an asset that has to be depreciated over a number of years. Property that qualifies for this tax break includes machinery, tools, furniture, fixtures, computers, software, and vehicles. (This special rule often goes by the alias "the Section 179 deduction" to give homage to the section of the tax law that allows it.) This deduction is limited in several ways: • Dollar limit. For assets placed in service in 2012, you can take a maximum expensing deduction of $500,000-a higher-than-normal level approved by Congress to help the struggling economy. • Investment limit. As a way to focus this tax break on smaller businesses, firms whose investment in new property exceeds a threshold amount gradually lose the right to expensing. For 2012, the investment threshold is $2,000,000. For example, if you purchased $2,020,000 of otherwise eligible equipment in 2012, you can't expense more than $480,000 (the $500,000 expensing maximum minus the excess investment of $20,000). • Taxable income limit. Your total first-year expensing deduction cannot exceed your business's taxable income. Say, for example, that you bought $40,000 of property eligible for expensing in 2012, but your firm's taxable income before taking expensing into account is just $20,000. That means your expensing deduction is limited to $20,000; you can carry over the disallowed $20,000 to 2013 and claim an expensing deduction then, assuming that you have sufficient business income. Questions Consider the professional and ethical standards and ethical reasoning methods discussed in Chapters 1 and 2 in answering the following questions. 1. Has the company properly handled the depreciation of the one item of machinery reflected on its income statement for the year ended December 31, 2012? Why or why not? 2. How would you handle the depreciation deduction for income tax purposes? 3. How should the controller handle the matter, assuming that the financial reports have not been issued as yet, and that he reasons at stages 3, 4, and 5 in Kohlberg's model?
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Phar-Mor The Dilemma The story of Phar-Mor shows how quickly a company that built its earnings on fraudulent transactions can dissolve like an Alka-Seltzer. One day, Stan Cherelstein, the controller of Phar- Mor, discovered cabinets stuffed with held checks totaling $10 million. Phar-Mor couldn't release the checks to vendors because it did not have enough cash in the bank to cover the amount. Cherelstein wondered what he should do. Background Phar-Mor was a chain of discount drugstores, based in Youngstown, Ohio, and founded in 1982 by Michael Monus and David Shapira. In less than 10 years, the company grew from 15 to 310 stores and had 25,000 employees. According to Litigation Release No. 14716 issued by the SEC, 1 Phar-Mor had cumulatively overstated income by $290 million between 1987 and 1991. In 1992, prior to disclosure of the fraud, the company overstated income by an additional $238 million. The Cast of Characters Mickey Monus personifies the hard-driving entrepreneur who is bound and determined to make it big whatever the cost. He served as the president and chief operating officer (COO) of Phar-Mor from its inception until a corporate restructuring was announced on July 28, 1992. David Shapira was the CEO of both Phar-Mor and Giant Eagle, Phar-Mor's parent company and majority stockholder. Giant Eagle also owned Tamco, which was one of Phar-Mor's major suppliers. Shapira left day-to-day operations of Phar- Mor to Monus until the fraud became too large and persistent to ignore. Patrick Finn was the CFO of Phar-Mor from 1988 to 1992. Finn, who holds the Certified Management Accountant (CMA) certification, initially brought Monus the bad news that following a number of years of eroding profits, the company faced millions in losses in 1989. John Anderson was the accounting manager at Phar-Mor. Hired after completing a college degree in accounting at Youngstown State University, Anderson became a part of the fraud. Coopers Lybrand, prior to its merger with Price Waterhouse, were the auditors of Phar-Mor. The firm failed to detect the fraud as it was unfolding. How It Started The facts of this case are taken from the SEC filing and a PBS Frontline episode called "How to Steal $500 Million." The interpretation of the facts is consistent with reports, but some literary license has been taken to add intrigue to the case. Finn approached Monus with the bad news. Monus took out his pen, crossed off the losses, and then wrote in higher numbers to show a profit. Monus couldn't bear the thought of his hot growth company that had been sizzling for five years suddenly flaming out. In the beginning, it was to be a shortterm fix to buy time while the company improved efficiency, put the heat on suppliers for lower prices, and turned a profit. Finn believed in Monus's ability to turn things around, so he went along with the fraud. Finn prepared the reports, and Monus changed the numbers for four months before turning the task over to Finn. These reports with the false numbers were faxed to Shapira and given to Phar-Mor's board. Basically, the company was lying to its owners. The fraud occurred by dumping the losses into a "bucket account" and then reallocating the sums to one of the company's hundreds of stores in the form of increases in inventory amounts. Phar-Mor issued fake invoices for merchandise purchases and made phony journal entries to increase inventory and decrease cost of sales. The company overcounted and double-counted merchandise in inventory. The fraud was helped by the fact that the auditors from Coopers observed inventory in only 4 out of 300 stores, and that allowed the finance department at Phar-Mor to conceal the shortages. Moreover, Coopers informed Phar-Mor in advance which stores they would visit. Phar-Mor executives fully stocked the 4 selected stores but allocated the phony inventory increases to the other 296 stores. Regardless of the accounting tricks, Phar-Mor was heading for collapse and its suppliers threatened to cut off the company for nonpayment of bills. Stan Cherelstein's Role Cherelstein, a CPA, was hired to be the controller of Phar-Mor in 1991, long after the fraud had begun. One day, Anderson, Phar-Mor's accounting manager, called Cherelstein into his office and explained that the company had been keeping two sets of books-one that showed the true state of the company with the losses and the other, called the "subledger," that showed the falsified numbers that were presented to the auditors. Cherelstein and Anderson discussed what to do about the fraud. Cherelstein was not happy about it at all and demanded to meet with Monus. Cherelstein did get Monus to agree to repay the company for the losses from Monus's (personal) investment of company funds into the World Basketball League (WBL). But Monus never kept his word. In the beginning, Cherelstein felt compelled to give Monus some time to turn things around through increased efficiencies and by using a device called "exclusivity fees," which vendors paid to get Phar-Mor to stock their products. Over time, Cherelstein became more and more uncomfortable as the suppliers called more and more frequently, demanding payment on their invoices. Accounting Fraud Misappropriation of Assets The unfortunate reality of the Phar-Mor saga was that it involved not only bogus inventory but also the diversion of company funds to feed Monus's personal habits. One example was the movement of $10 million in company funds to help start the WBL. False Financial Statements According to the ruling by the U.S. Court of Appeals that heard Monus's appeal of his conviction on all 109 counts of fraud, the company submitted false financial statements to Pittsburgh National Bank, which increased a revolving credit line for Phar-Mor from $435 million to $600 million in March 1992. It also defrauded Corporate Partners, an investment group that bought $200 million in Phar-Mor stock in June 1991. The list goes on, including the defrauding of Chemical Bank, which served as the placing agent for $155 million in 10-year senior secured notes issued to Phar- Mor; Westinghouse Credit Corporation, which had executed a $50 million loan commitment to Phar-Mor in 1987; and Westminster National Bank, which served as the placing agent for $112 million in Phar-Mor stock sold to various financial institutions in 1991. Tamco Relationship The early financial troubles experienced by Phar-Mor in 1988 can be attributed to at least two transactions. The first was that the company provided deep discounts to retailers to stock its stores with product. There was concern early on that the margins were too thin. The second was that its supplier, Tamco, was shipping partial orders to Phar-Mor while billing for full orders. Phar-Mor had no way of knowing this because it was not logging in shipments from Tamco. After the deficiency was discovered, Giant Eagle agreed to pay Phar-Mor $7 million in 1988 on behalf of Tamco. Phar-Mor later bought Tamco from Giant Eagle in an additional effort to solve the inventory and billing problems. However, the losses just kept on coming. Back to the Dilemma Cherelstein looked out the window at the driving rain. He thought about the fact that he didn't start the fraud or engage in the cover-up. Still, he knows about it now and feels compelled to do something. Cherelstein thought about the persistent complaints by vendors that they were not being paid and their threats to cut off shipments to Phar-Mor. Cherelstein knows that without any product in Phar-Mor stores, the company could not last much longer. Questions 1. How do you assess blame for the fraud? That is, to what extent was it caused by Finn's willingness to go along with the actions of Monus? What about Shapira's lax oversight? Should all the blame go to Monus? What role did Coopers Lybrand play with respect to its professional judgment? 2. Assume Cherelstein decides to use Rest's Model of Morality to reason out what the right thing to do is and how to carry out the action. Apply the logic of the model to Cherelstein's decision-making process. What do you think he should do at this point and why? 3. What is the ethical message of Phar-Mor? That is, explain what you think is the moral of this story. 1 Securities and Exchange Commission, Litigation Release No. 14716, November 9, 1995, SEC v. Michael Monus, Patrick Finn, John Anderson and Jeffrey Walley Case No. 4:95, CV 975 (N.D. OH, filed May 2, 1995), www.sec.gov/litigation/litreleases/lr14716.txt.
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In the text, we point out that Rest's model is not linear in nature. An individual who demonstrates adequacy in one component may not necessarily be adequate in another, and moral failure can occur when there is a deficiency in any one component. Give an example in accounting when ethical intent may not be sufficient to produce ethical behavior and explain why that is the case.
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Using the child abuse scandal at Penn State discussed in Chapter 1, explain the actions that would have been taken by Joe Paterno if he had been reasoning at each stage in Kohlberg's model and why.
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The following story applies to questions 1 and 2: On October 15, 2009, in Fort Collins, Colorado, the parents of a six-year-old boy, Falcon Henne, claimed that he had floated away in a homemade helium balloon that was shaped to resemble a silver flying saucer. Some in the media referred to the incident as "Balloon Boy." The authorities had closed down Denver International Airport, called in the National Guard, and a police pursuit ensued. After an hour-long flight that covered more than 50 miles across three counties, the empty balloon was found near the airport. It was later determined that the boy was hiding in the house all along in an incident that was a hoax and motivated by publicity that might lead to a reality television show. The authorities blamed the father, Richard, for the incident and decided to prosecute him. Richard Heene pleaded guilty on November 13, 2009, to the felony count of falsely influencing authorities. He pled to protect his wife, Mayumi, a Japanese citizen, who he believed may have been deported if Richard was convicted of a more serious crime. Richard also agreed to pay $36,000 in restitution. Some empirical research suggests that accountants and auditors may not achieve their higher levels of ethical reasoning. Why do you think this statement may be correct?
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The following story applies to questions 1 and 2: On October 15, 2009, in Fort Collins, Colorado, the parents of a six-year-old boy, Falcon Henne, claimed that he had floated away in a homemade helium balloon that was shaped to resemble a silver flying saucer. Some in the media referred to the incident as "Balloon Boy." The authorities had closed down Denver International Airport, called in the National Guard, and a police pursuit ensued. After an hour-long flight that covered more than 50 miles across three counties, the empty balloon was found near the airport. It was later determined that the boy was hiding in the house all along in an incident that was a hoax and motivated by publicity that might lead to a reality television show. The authorities blamed the father, Richard, for the incident and decided to prosecute him. Richard Heene pleaded guilty on November 13, 2009, to the felony count of falsely influencing authorities. He pled to protect his wife, Mayumi, a Japanese citizen, who he believed may have been deported if Richard was convicted of a more serious crime. Richard also agreed to pay $36,000 in restitution. How do you assess at what stage of moral development in Kohlberg's model you reason at in making decisions? Are you satisfied with that stage? Do you believe there are factors or forces preventing you from reasoning at a higher level? If so, what are they?
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The Tax Return Brenda Sells sent the tax return that she prepared for the president of Purple Industries, Inc., Harry Kohn, to Vincent Dim, the manager of the tax department at her accounting firm. Dim asked Sells to come to his office at 9 a.m. on Friday, April 12, 2013. Sells had no idea why Dim wanted to speak to her. The only reason she could come up with was the tax return for Kohn. "Brenda, come in," Vincent said. "Thank you, Vincent," Brenda responded. "Do you know why I asked to see you?" "I'm not sure. Does it have something to do with the tax return for Mr. Kohn?" asked Brenda. "That's right," answered Vincent. "Is there a problem?" Brenda asked. "I just spoke with Kohn. I told him that you want to report his winnings from the lottery. He was incensed." "Why?" Brenda asked. "You and I both know that the tax law is quite clear on this matter. When a taxpayer wins money by playing the lottery, then that amount must be reported as revenue. The taxpayer can offset lottery gains with lottery losses, if those are supportable. Of course, the losses cannot be higher than the amount of the gains. In the case of Mr. Kohn, the losses exceed the gains, so there is no net tax effect. I don't see the problem." "Let me tell you the problem," Vincent stated sharply. "It's taken me years to gain Kohn's trust. Our firm now audits his company's books, prepares its annual tax return, prepares Kohn's personal tax return, and provides financial planning services for both. Kohn and Purple Industries together are the largest clients in our office. I can't afford to lose any of the business these clients provide for our firm. As you know, we are under increasing competition from larger regional firms that are looking for new clients. If we don't support Kohn, some other firm will step in and do it. Poof, there goes 20 percent of our revenues." Brenda didn't know what to say. Vincent seemed to be telling her the lottery amounts shouldn't be reported. But that was against the law. She turned to Vincent and asked: "Are you telling me to forget about the lottery amounts on Mr. Kohn's tax return?" "I want you to go back to your office and think carefully about the situation. Consider that this is a one-time request and we value our staff members who are willing to be flexible in such situations. Let's meet again in my office tomorrow at 9 a.m." Questions 1. Assume that Brenda has no reason to doubt Vincent's veracity with respect to the statement that it is "a one-time request." Should that make a difference in what Brenda decides to do? Why or why not? 2. Analyze the alternatives available to Brenda using Kohlberg's six stages of moral development. That is, what would Brenda's position be when she meets with Vincent assuming that her judgment was influenced by relevant factors at each of the six different stages of moral development? 3. Assume that Brenda decides to go along with Vincent and omits the lottery losses and gains. Next year, the same situation arises, but now it's with gambling losses and gains. If you were Brenda, and Vincent asked you to do the same thing you did last year regarding omitting the lottery losses and gains, what would you do this second year? Why?
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Gateway Hospital Troy just returned from a business trip for health care administrators in Orlando. Kristen, a relatively new employee who reports to him, also attended the conference. Troy works for Gateway Hospital, a for-profit hospital in the St. Louis area. The Orlando conference included training in the newest regulations over health care, networking with other hospital administrators, and reports on upcoming legislation in health care. The conference was in early March and coincided with Troy's kids school spring break, so the entire family traveled to Orlando. The hospital's expense reimbursement policy is very clear on the need for receipts for all reimbursements. Meals are covered for those not included in the conference, but only within a pre-set range. Troy has never had a problem following those guidelines. However, the trip to Orlando was more expensive than Troy expected. He did not attend all sessions of the conference to enjoy time with his family. Upon return to St. Louis, Troy's wife suggested that Troy submit three meals and one extra night at the hotel as business expenses, even though they were personal expenses. Her rationale was that the hospital policies would not totally cover the business costs of the trip. Troy often has to travel and misses family time that cannot be recovered or replaced. Troy also knows that his boss has a reputation of signing forms without reading or careful examination. Kristen is approached by the head of the accounting department about Troy's expenses, which seem high and not quite right. Kirsten is asked about the extra night because she did not ask for reimbursement for that time. Kristen knows it can be easily explained by saying Troy had to stay an extra day for additional meetings, a common occurrence for administrators, although that was not the case. She also knows that the hospital has poor controls and a culture of "not rocking the boat," and that other employees have routinely inflated expense reports in the past. Assume that you are in Kristen's position. How would you respond to the inquiry of the head of the accounting department? In considering your response, address the following issues. Questions 1. What is at stake for the key parties? What is at stake for you [Kristen]? 2. What are the main arguments that you are trying to counter, assuming that you know Troy's position on the matter, and what are the reasons and rationalizations that you need to address? 3. What should Kristen do and what ethical considerations should influence her decision?
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