Case Study: Resolving Accounting Irregularities in Towers Inc.

Background of Towers Inc.

Towers Inc. (TI) is a leader in delivering communications technology that powers global commerce and secures the world's most critical information. Its shares trade on the Canadian and U.S. national stock exchanges. The company had been experiencing unprecedented growth, but then, in 2018, industry demand for the company's services and products declined dramatically due to an industry realignment, an economic downturn, and a tightening in global capital and product markets. By the end of 2020, the industry stabilized and the company began to enter a turnaround period after significant downsizing.

In 2020, employee morale was very low because of all the downsizing. Many employees were being actively recruited away from TI. Management decided to set up bonus programs for employees who stayed to see the company through the difficult times and back to profitability. Under one plan, every employee would receive a bonus in the first quarter that the company achieved enough profit to cover the bonus costs. In order to help achieve profitability, the CFO met with the managers of his divisions and established profitability targets and what he called “roadmaps” that showed how these targets could be achieved. The roadmaps included statements that the profits could be achieved only through the release from the statement of financial position of excess provisions (that is, provisions for obsolete inventory and bad debts). The provisions had been overprovided for in earlier years in an effort to “manage” profits.

In 2021, the company came under scrutiny from the securities regulators. The government notified it of a criminal investigation into alleged accounting irregularities. In addition, there were several class-action lawsuits outstanding against the company by shareholders alleging that TI had provided misleading information to them in the financial statements for 2019 and 2020. Once news of this was released, credit-rating agencies significantly downgraded their ratings of TI's securities. As a result of this negative activity, the company had not released its financial statements for 2021 and was now in breach of stock exchange requirements to file financial statements. Although the stock exchanges had not done so, they now had the power to delist TI's shares.

The controller of TI must now finalize the financial statements and has come across the following information.

1. During the year, the company signed contracts to sell optical software products. Before year end company shipped out what it called an interim product solution in other words, the optical software product ordered by the company was not yet ready in its final form so the company shipped a beta or draft version of it. This interim product would be followed shortly by the final version. Revenues were recognized upon shipment of the interim product solution, as it was felt that the final version just needed minor refinements. The customers generally paid more than half of what was owed under the contract when they received the interim product solution. It was rare for customers to back out of this type of contract for any reason.

2. In 2020, TI had purchased a subsidiary of DEF Inc. and agreed to pay additional future consideration for the purchase (the consideration would take the form of additional TI shares). The additional consideration was a function of the profitability of the subsidiary. The more profitable the subsidiary, the more shares that TI would issue as consideration. Given that TI's shares are highly volatile, TI and DEF agreed that the number of shares to be issued should be based on the average price per share in the three months prior to the future issuance date of the shares. So far, the subsidiary has been performing above expectations.

3. By the end of 2021, TI was still restructuring to streamline its core operations and activities. Part of the restructuring included abandoning its voice-over-fibre operations. The operations would be closed down in early 2022, and this would involve workforce reductions and abandonment of plant and equipment.