For the first nine months of 2006, the Anderson Company is experiencing significantly lower earnings than it had forecast due to unidentified reasons. Management begins to search for ways to increase earnings during the last quarter of the year and thereby calm the fears of their stakeholders.
The Controller is called into a meeting of the top management team and submits the following plan:
- Anderson should issue $1,000,000 of bonds and use the proceeds to acquire the outstanding 15 year, 10 percent bonds of its subsidiary.
- The subsidiary bonds currently sell at 90.
- Five years ago, the subsidiary bonds were issued at a premium that totaled $75,000.
- Anderson’s borrowing rate is 12 percent.
- This transaction creates a $150,000 gain that can be reported in 2006, thus bringing earnings up to the forecast amount.
Prepare a brief essay that evaluates the validity, both practically and ethically, of the controller’s plan.