Case Study
Don Russell:
Experiences of a
Controller/CFO
GROUP 4
Introduction
In 1991, Don Russell, chief financial officer (CFO) at
Eastern Technologies, Inc. (ETI) Don had joined ETI only
14 months earlier and had gradually become convinced
that the company’s financial accounting was
excessively aggressive. He thought a sizable correcting
entry should be made immediately. But if the correction
was made, ETI would report a large loss that would
trigger violations of debt financing covenants and place
the company’s survival in jeopardy. ETI’s chairman and
president were strongly against making the correcting
entry.
he had seen the dangers of manipulating earnings
reports at his previous employer. But he knew that if he
forced the change now, he would lose his job
Don
Early Carrier Russel
Don attended DePaul Don left T&Y to become
University’s evening MBA corporate controller
program and earned his degree for Cook & Spector, Inc.
in management information
system
1973 1975 1983- 1985
joined the audit staff of
1984
he was promoted to senior
the Chicago office
manager. Don’s time was
of Touche & Young
split almost equally
between auditing and
systems consulting
Controllership experiences at
Cook & Spector
Systems development activities
• planning the changes to the firm’s accounting
information systems
• changed the chart of accounts so that the firm
could produce profit and loss statements
down to the product level
• After the accounting systems were
computerized, Don found it easy to reduce
costs in the controller’s department. He
reduced his accounting staff from 250 to 110
and saved the company over $4 million per
year
Earnings management activities
In 1985, for a variety of reasons, C&S’s profit performance
was running $45 million ahead of the $200 million plan. To
save the profit for periods when it might be
needed, Don established several types of large reserve:
-set up a large reserve ($53
million) for taxes
-set up reserves for unknown liabilities
In 1986, company sales and profits were below forecast and
top management told Don they wanted to use some of the
reserves
Corporate recognition
Don’s superiors were ecstatic
about his efforts. After a year,
with the company, he was
He had modernized the company’s promoted to vice
accounting systems; had saved the president/controller
company $4 million in overhead annually;
and had demonstrated great skill in
managing the accounting profit numbers.
Concerns about earnings management
During his third year at C&S, Don began to have concerns about his manipulations
● had a record of 33 consecutive years of increasing quarterly earnings. But real
results, with recessions and hadn’t invented earnings management at C&S.
● Divisions manipulating numbers on their own. They had not really spent the
promotion expense by products as was reported, and they had their own buries
reserves
● While the company was reporting profits, Don thought we were headed in a
downward spiral. The old products were still extremely profitable, but we were
spending a huge amount of money on new products and were disguising the fact
that the new products were a lot less profitable.
Attempts to change the company’s
financial goals and measurement system
To improve company decision-making and reduce the
temptations to manage earnings, Don decided to try to
change C&S’s financial goals and measurements system.
He was particularly concerned that the potentially
lucrative bonuses, ranging up to 70–100% of base salary,
were based on operating profit numbers that were too
easy to manipulate.
He began a fact-finding study. He began interviewing all
the C&S division heads on his own and soon realized that
the company was not doing any real strategic planning.
Attempts to change the company’s
financial goals and measurement system
Don planned to take his interview observations to the president and tell him:
We’ve got a big problem here because we’re not managing the company the way we
should be. We’re spending four times the amount of product development and
capital expenditures we need because it’s easy to get Queen’s to approve them. But
Queen’s assumes we are making good decisions, and we’re not.
But Don wanted to be able to propose an alternative, and he set out looking for “the
Holy Grail of more reasonable financial reporting.”
Don learned that some companies were experimenting with an approach to planning
that focused on changes in shareholder value. This focused measurement attention
on hard numbers – cash flows – rather than the easily manipulatable operating profit.
ANALYSIS
• The controller function deals primarily with financial record-keeping, reporting,
and control .
• Here are some prove that Don was a good controller for C&S-Successfully
implemented major changes in the firm's accounting information systems :
1. He reduced his accounting staff from 250 to 110 and saved the company over $4
million per year.
2. Don find manipulations of reserves and to improve company decision-making and
reduce the temptations to manage earnings.
3. Don decided to try to change C&S’s financial goals and measurements system but
Don Was not able to convince top management that they needed to implement a
different form of financial measurement system and to fix the earnings
management problem.
And after that
He left company and resign without solving the problem because Don’s job
became more routine, and he became bored and search for another carreer
The Decision To Leave
As the pace of accounting systems change slowed, Don’s job
became more routine, and he became bored. He began
listening for other career opportunities.
He thought he wanted to become a Chief Financial Officer
so that he could work more in finance areas where he had
had no experience.
In early 1989, a headhunter approached Don with an
opportunity to interview for the position of CFO of Eastern
Technologies, Inc. (ETI), a public communications services
company. He was interviewed for the job and accepted it
when it was offered. He joined ETI on December 1, 1989.
Eastern Technologies, Inc (ETI) Company
▪ revenues were $30 million and
profits were just above $1 million
with an initial offering
price of $11.00 per share ▪ year-end stock price was $8.75
Go Public Fiscal Year
1978 1984 1987 1988
Founded Diversify
As a cable television firm ETI’s founder decided to diversify the
company’s operations into the fast-
growing area of satellite broadcasting
Eastern Technologies, Inc (ETI) Company
▪ To finance the construction of antennas and distribution networks
throughout the Northeast, ETI raised considerable bank financing.
▪ By the end of 1987, ETI’s debt–equity ratio was 4 to 1, but management
figured the company still needed $10 million of additional capital.
▪ They approached a prominent investment banking firm to make a bond
offering. When the bonds sold, the company had considerable cash but a
debt–equity ratio of 6 to 1.
▪ ETI made another acquisition in February 1990. This was of a Southern
California-based consulting firm that provided specialized
communications services primarily to firms in the defense industry.
Transition of Power
▪ When Don joined ETI his major concern was whether ETI’s president,
Joe Blevins, would allow him autonomy in his CFO role.
▪ Joe was a former T&Y audit partner who had joined ETI in 1987.
▪ Joe asked Don : ETI had no computerized systems, no planning, and
no budgeting, and the controller was weak.
▪ But Joe let Don sit in on the discussions with bankers and
investment bankers to help him learn the treasury functions that he
would eventually assume.
▪ Don quickly found that ETI’s financial focus was on earnings per
share, and he vowed to change the focus to cash flow.
▪ Joe said, however, “You don’t really understand the market. I’ll listen
to your thoughts, but EPS is what the analysts care about. Cash flow
may be the latest voodoo thought, but it’s not very realistic.”
Transition of Power
Don, however, had a lot of work to do before he could focus on changes
in the company’s planning and measurement processes.
He focused his attention first on ETI’s chart of accounts. Don also had to spend
time integrating the
For example, the company paid huge bills for satellite
systems of the newly
rental and telephone services with no attempt to trace
acquired subsidiaries.
the expenses to contracts or even product lines.
He found ETI to be
Another complicating factor: many of the charges were
much more dynamic
not billed regularly, so expenses had to be accrued.
than C&S. At C&S he
Changing the chart of accounts proved to be a difficult had time to plan what
process because few people in the company he wanted to do. At ETI
understood what Don was trying to do. The controller he had to implement
was not supportive. He was comfortable with the changes quickly and
current chart of accounts and liked the fact that it was hope to fine-tune the
easy to work with. systems later.
ETI’S FIRST BUDGETING PROCESS
1 3
Don led ETI through its first
formal budgeting process in June– Operating managers had failed to
July 1990. Budgets were prepared pass the information to accounting
for each division using the personnel, and two months into the
categories in Don’s new chart of year, some significant unbudgeted
accounts. expenses had to be paid.
2
the budget for fiscal year 1991 was
consolidated, it showed a $2 million
loss. This was the first budget that
had been prepared at the division
level, and no division-level historical
reports were available for comparison
purposes
ETI’S FINANCIAL REPORTING STRATEGY
ETI had been reporting profits because the company had implemented an extremely aggressive
financial reporting strategy. Joe used a number of methods of boosting earnings :
● Virtually all repairs and maintenance were
capitalized
● Most interest was capitalized because it was
deemed to be the cost of financing the
construction in progress
● Most equipment was being depreciated on a
12-year life
● As many expenditures as possible (for example, travel)
were classified as being related to one of the
acquisitions so that they would add to goodwill and be
amortized over 40 years instead of being expensed
immediately.
Top three Problem Auditor in ETI
1
The auditors had not objected
strenuously to ETI’s financial
reports because they did not 01
understand the technology
2
Few equipment retirements had
taken place as yet, so it was 02
difficult to tell what the true
equipment lives were.
3
The auditors had a feeling that 03
there were some repairs and
maintenance being capitalized, but
they never really found it
Year end 1990
● Don went to Joe and proposed a large accounting adjustment, of nearly $2 million,
approximately twice the amount ETI would otherwise report as 1990 profit.
● Joe was negotiations in 1989 with National Telephone Corporation (NTC). NTC had
offered to buy a new offering of ETI stock at a substantial premium over market
price.
● This business was seen to have a large potential market in providing easy
telephone communications to remote areas.
● ETI managers knew that the NTC deal was important both for the opportunity to
enter a new business and for the infusion of cash that would allow the retirement
of some expensive bonds.
● As we know ETI boost their earnings so looks like they have much profit, and if
NTC find this problem maybe they will back off.
● auditors gave the ETI 1990 financial statements an unqualified opinion, although
they told the board of directors that the statements were pushing the edge on
aggressive reporting.
What DON Feels?
● Don felt ETI should not be reporting as it did.
● Don felt that the problem would be fixed in 1991 as a lot of goodwill
amortization and depreciation of equipment put in service would have to be
recognized as expense.
● Don was also appeased because management had agreed to limit
expenditures, and Joe had finally agreed to let him change the company’s
measurement focus from EPS to cash flows.
● Don say “I thought if people looked at cash flows they would
understand what was going on.”
● “We had disclosed how much interest we had capitalized. I thought
that someone who was smart and took the time would be able to draw
the right conclusions from our disclosures.”
Fiscal year 1991
• The budget proved to be reasonably accurate in the first quarter of
fiscal year 1991 and he sure company would actually report something
close to the $2 million loss that had been forecast unless changes were
made.
• But in January 1991 ,manager of the satellite video division dropped his
$3.5 million operating profit projection for the year to $1.5 million, so
company profits were now forecast at a $4 million loss for the
year.
• So Don decide tu visit all president divison and ask them to raise their
profit forecast.
• And here we are, the president said that was imposible because the
president made bad error and fired salesman because the sales below
target, and he said “bahwa dia telah menganggarkan tingkat penjualan
yang agresif yang dia tahu sejak awal tidak dapat dia capai”
The rest of ETI’s top management team still did not put great faith in the
budget numbers, and they had not cut costs as sharply as Don Would like.
Don Russel
Don wondered what he should do. Should he continue to work on
improving the company’s accounting and budgeting systems and
keep trying to convince top management that ETI had a serious
financial problem on its hands? Or should he force the issue by
making the accounting adjustment and hope that the company
(and his job) survived the loss?
PROBLEM ANALYSIS
While he was involved in the company's budgeting process,
Don learned that ETI had reported earnings with a "very
aggressive financial reporting strategy." Among other things,
ETI management has capitalized on many questionable
expenses. So what the correct action that must do by Don ?
AS GOOD ACCOUNTANT:
- Confront the auditor and tell everything that he knows
about the company especially about repairs and maintenance
being capitalized, but it feels like he confront the company.
-Made accounting entries to write off what it concluded
were some improper assets that were in existence because
of excessive past earnings.
PROBLEM ANALYSIS
Auditor provides ETI 1990 financial report unqualified
opinion, even if they notify the board directors that
statement pushed the edge on aggressive reporting. Before
the auditor gives their opinion they look like have discuss with
Joe.
As group we can conclude that the auditor is not
INDEPENDENT as they should, because they make opinion by
the request of client.
and we can indicate that the “auditor” is less competence
because they not trying to get much evidence from the ETI
they just believe what the Joe says.
AUDITOR ANALYSIS
• The auditors had not objected strenuously to ETI’s financial reports because they did
not understand the technology.
• Don also noted:The auditors had a feeling that there were some repairs and
maintenance being capitalized, but they never really found it. The auditors weren’t
thorough enough. If they had studied it carefully they would have found, for example,
that it takes $400,000 per year to maintain each of the fancy video tape decks.-
• Don concluded that auditors provide no safety net at all against financial people in a
company
Solution
• Auditors must have qualifications ties to a professional association that sets
professional standards like GAAP, adopts a code of ethics, develops a common body of
knowledge for auditors, and runs certification programs leading to the qualification of
"Certified Auditor"
SOLUTION
• As group we conclude that financial report made by ETI can effect that decision make
by the stakeholder.
Problems arise when many of Don's policies were disapproved of by Joe and divisional management. In the end, many
problems occurred, including losses that were initially estimated at only $ 2 million, which increased to $ 4 million.
There was also the problem that arose because the division president fired a pair of sales members and his sales fell
below the target.
As a good controller Don maybe can doing write off inappropriate assets, maybe this activity can make the company
look bad and there is risk Don loose his job but at least he doing the right thing as controller
But if Don continue to work on improving the company’s accounting and budgeting systems and keep trying to convince
top management that ETI had a serious financial problem. He can negotiate to top management and tell them there is
financial problem in company by explaining that if capitalizing repairs and maintenance as well as interest
capitalization will have an impact on lower profits for the next period when compared to charging costs. For example,
in the Don Russell case, the market (smart analysts) would not be able to determine how many expenses had been
erroneously capitalized, and the company could derive a short-term stock price benefit from managing earnings.
Similarly, the company's loan prospects could improve with cosmetic financial statement improvements. And managers
could benefit personally through bonuses, raises, and promotions.
And ETI also must give Don Autonomy for making decision as CFO.
