The reclassification of long term investments by Ross’s Lipstick as a short term will increase the current assets by the amount of reclassified assets. An increase in the current assets leads to an improvement in the current ratio from its current state of 1.47. However, the company’s financial position has not improved as a result of reclassification because the total assets have not changed (Horngren, 2014).
Ross's Lipstick will have a positive outlook on its ability to pay for liabilities when they fall due. As a temporary measure, the company will not be faced by management takeover by its lenders. The reclassified asset can be sold by the administration to pay for short term liabilities as they fall due. The company will also be in a position to seek additional funds from external sources if the current situation persists without exposing the shareholder's funds to the lenders (Horngren, 2014).
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By reclassifying the investment into a current asset, Ross will be able to sell the investment within the year and improve its liquidity. A liquid company is not exposed to short term cash challenges and can settle its bills as they arise. Similarly, the company will be able to maintain its operations as conditions in the market stabilize (Campbell, 2011; Horngren, 2014).
Even if the company sold the investment, its financial position would not improve because the proceeds from the sale will balance with the cash at hand. However, if the company sell the investment at a higher value than its book value, its financial position will improve by the amount above the book value (Campbell, 2011; Horngren, 2014).
Judging on whether the management acted ethically or not depends on the circumstances that they are exposed. The company has to meet all the three conditions and a deviation from one result to a management takeover. Ross Lipstick, in this case, has met the first two conditions but the current ratio has dropped below 1.50 as agreed with the lenders which mean that if the company publishes its results in its currents status, the lenders will take over its management (Campbell, 2011; Horngren, 2014).
According to the example, the reduction of the current ratio to 1.47 was caused by changes in consumer demand which are beyond the control of the management. A solution has to be sought to address the issue, and it was acceptable for the administration to classify the investment as a current asset to protect the company from its lenders. The management, in this case, acted in the interest of the company by looking for a solution to an imminent problem (Campbell, 2011; Horngren, 2014).
The reclassification of the asset into long term investment after the sales and current ratio improved does not amount to unethical practices. This is because the management intention was to safeguard the interest of the company from the lenders. Their intention was to protect the company from management takeover as a result of a low current ratio which was caused by factors beyond their control. By classifying the investment as a current asset, the management could have sold it and use the proceeds to pay short term debts (Campbell, 2011; Horngren, 2014).
As the situation improved and the company sales grew, it was prudent for the management to reclassify the investment back to fixed asset. The administration would have acted unethically if they acted intentionally for their own benefit and not the companies.
It is the responsibility of the management to protect the assets of the enterprise, and their action amounted to this. As the sales and current ratio improved, Ross Lipstick does not need to sell its asset in that year and therefore reclassifying it back to fixed asset was a move in the right direction. However, it can be argued that the management acted unethically by engaging in practices that do not represent the true and fair view of the company (Campbell, 2011; Horngren, 2014).
For businesses to operate sustainably, they need to have strong corporate governance, internal controls and be transparent. They need to make full, timely and accurate disclosure of their revenues, losses, and expenditures. Investors should receive accurate information on time to assist them in decision making. It is therefore unethical to misrepresent financial information knowingly or unknowingly for selfish interest (Campbell, 2011; Horngren, 2014).
References
Campbell, D. (2011). Accounting and business ethics: An introduction. The British Accounting Review , 43(1), pp.73-74.
Horngren, C. (2014). Introduction to financial accounting . Harlow: Pearson Education.
