Bryan Eubank began his accounting career as an auditor

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Bryan Eubank began his accounting career as an auditor for a Big 4 CPA firm. He focused on
clients in the high-technology sector, becoming an expert on topics such as inventory write-
downs, stock options, and business acquisitions. Impressed with his technical skills and
experience, General Electronics, a large consumer electronics chain, hired Bryan as the
company controller responsible for all of the accounting functions within the corporation. Bryan
was excited about his new position—for about a week until he took the first careful look at
General Electronics’ financial statements.
The cause of Bryan’s change in attitude is the set of financial statements he’s been staring at
for the past few hours. For some time prior to his recruitment, he had been aware that his new
employer had experienced a long trend of moderate profitability. The reports on his desk
confirm the slight but steady improvements in net income in recent years. The disturbing trend
Bryan is now noticing, though, is a decline in cash flows from operations. Bryan has sketched
out the following comparison ($ in millions):

Profits? Yes. Increasing profits? Yes. So what is the cause of his distress? The trend in cash
flows from operations, which is going in the opposite direction of net income. Upon closer
review, Bryan noticed a couple events that, unfortunately, seem related:
a. The company’s credit policy has been loosened, credit terms relaxed, and payment periods
lengthened. This has resulted in a large increase in accounts receivable.
b. Several of the company’s salary arrangements, including that of the CEO and CFO, are
based on reported net income.

Required:
1. What is likely causing the increase in accounts receivable? How does an increase in
accounts receivable affect net income differently than operating cash flows?
2. Explain why salary arrangements for officers, such as the CEO and CFO, might increase the
risk of earnings management.
3. Why is the trend in cash flows from operations, combined with the additional events, such a
concern for Bryan?
4. What course of action, if any, should Bryantake?

Bryan Eubank began his accounting career as an auditor for

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