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Tappit is a medium-sized wholesaler of automotive parts. It has 10 stockholders who have been paid a total of $1 million in cash dividends for 8 consecutive years. The board's policy requires that, for this dividend to be declared, net cash provided by operating activities as reported in Tappit's current year's statement of cash flows must exceed $1 million. President and CEO Willie Morton's job is secure so long as he produces annual operating cash flows to support the usual dividend.

At the end of the current year, controller Robert Jennings presents president Willie Morton with some disappointing news: The net cash provided by operating activities is calculated by the indirect method to be only $970,000. The president says to Robert, "We must get that amount above $1 million. Isn't there some way to increase operating cash flow by another $30,000?" Robert answers, "These figures were prepared by my assistant. I'll go back to my office and see what I can do." The president replies, "I know you won't let me down, Robert."

Upon close scrutiny of the statement of cash flows, Robert concludes that he can get the operating cash flows above $1 million by reclassifying a $60,000, 2-year note payable listed in the financing activities section as "Proceeds from bank loan$60,000." He will report the note instead as "Increase in payables$60,000" and treat it as an adjustment of net income in the operating activities section. He returns to the president, saying, "You can tell the board to declare their usual dividend. Our net cash flow provided by operating activities is $1,030,000." "Good man, Robert! I knew I could count on you," exults the president. Share your thoughts about this situation. Who is affected by this change in the treatment of the debt? Is this illegal? Is it unethical? Are the board members or anyone else likely to discover the misclassification? Can you see how management and the accountants could be tempted to make this change?

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