Creative Toys Inc.

1
Creative Toys Inc.

• An Ethical Decision

2
Facts

• Sharon Browne CPA, CMA, Controller
• Creative Toys financially successful due mostly
  to Chatter Chick product
• 2004 decreasing demand for Chatter Chick
  product due to competition - but inventory levels
  increasing
• Discounting of price in 1st Quarter of 2005 has
  reduced NRV of inventory to 10 below cost

3
Facts (cont.)

• Browne recommends to CFO and CEO an establishment
  of an inventory allowance for 2004 annual
  financial statements
• BOD questions CEO and CFO why allowance not
  established
• CFO, CEO, BOD concerned about an allowances
  effect on Public Offering and ability to raise
  capital
• Internal Auditors question absence of Inventory
  Allowance

4
Facts (cont.)

• Browne again recommends to CFO and CEO an
  establishment of an inventory allowance for 2005
  quarterly financial statements to be issued as
  part of Public Offering
• Browne informed that allowance would negatively
  impact financial performance and bonuses of top
  executives
• Browne also informed that allowance would
  negatively affect employees and stockholders

5
Accounting Issues

• APBO 28 integral theory of interim financial
  statements states interim period should be viewed
  as integral part of annual financial statements
• APBO 28 inventory losses from market declines
  should not be deferred beyond the interim date in
  which the decline occurs unless they can
  reasonable be expected to be restored
• Conservative approach to LCM
• Delay in Write-down of inventory could mislead
  stockholders

6
Accounting Issues

• Interim Reports to SEC do not have to be audited
• SAS 71 (Interim Financial Information) does not
  apply to 2004 audited financial statements
• SAS 37 (Discovery of GAAP Departure) does apply
  to 2005 audited financial statements
• Auditors will have to extend 2005 audit work and
  modify report and describe GAAP departure

7
Accounting Issues (cont.)

• Treadway Commission recommends independent CPA
  firm review quarterly data before releasing to
  public
• Treadway Commission recommends Audit Committee
  must be viligant, informed, diligent, and probing

8
Operational Issues

• Audit Committee of BOD passive
• Audit Committee should have open lines of
  communication with chief accounting officer and
  chief internal auditor
• Audit Committee should work with controller to
  resolve differences
• BOD concerned more with the write-downs effect
  on public offering rather than proper accounting

9
Stakeholders

• Creative Toys
• Top Corporate Officials
• Employees
• Customers
• Shareholders and potential investors
• Creditors
• Internal and External Auditors
• SEC

10
(No Transcript)
11
Ethical Analysis

• Tone at the Top more concerned with appearance
  of Financial Statements rather than proper
  accounting
• Control Enviornment unethical corporate
  structure
• Browne asked to put interests of top management
  and entity ahead of proper accounting
• Fiduciary responsibility to stockholders and
  potential investors

12
Ethical Analysis (cont.)

• Utilitarian perspective select action that
  maximizes benefits and minimizes harm to the
  stakeholders
• Rule Utilitarian Browne obligated to follow
  AICPA and IMA rules of professional conduct
• Not subordinate judgment
• Communicate all relevant information timely
• Integrity standard to communicate both favorable
  and unfavorable information

13
Ethical Analysis (cont.)

• Theory of Rights potential investors have a
  right to receive accurate information
• Theory of Justice Browne should fairly and
  impartially consider the interests of all
  stakeholders, not just top management
• Virtue Theory Honesty, impartiality,
  trustworthiness, integrity
• loyalty to company (Whistle-Blowing)

14
Action

• Personally bring issue to BOD attention
• Insist on Write-Down
• Consider resigning position even if BOD agrees
  with write-down

15
The Right Decision

• Meets AICPA and the IMA Ethical Standards
• Stockholders might sue the company
• External auditor inevitable questions
• The Right Thing To Do for majority of
  stakeholders
• Future employment with ethical company