The Pearl of The Orient Health Care Company: A Case Study

The Pearl of the Orient Health Care Company:
A Case Study
The Context
Matt delos Reyes is married with three children, ages 2, 6 and 10. His wife was recently
laid off from a large airline company. At this time, her job prospects look bleak since her
career was oriented toward the airline industry which has been negatively impacted by
the corona virus 2019.
Matt is a licensed CPA who recently accepted a position as the controller of The Pearl
of the Orient Health Care Company, a not so large company specializing in providing
healthcare services. Until recently, Matt was working for a large CPA firm where he had
a variety of audit clients. Matt was tired of the long hours and the pressure of public
accounting and believed that working in this health care company would be relatively
free of stress and that the hours would be more predictable. When he accepted the
position of controller at The Pearl of the Orient Health Care Company, Matt received an
increase in compensation. Since he came to work for the Pearl of the Orient, Matt has
heard that the prior controller was terminated and that it was a messy termination and
that a wrongful termination lawsuit is pending.
The Pearl of the Orient derives about eighty percent of its revenue from contracts with
the local and the national government agencies as well as state colleges and
universities (SUCs) for their employees’ health care services. The remaining twenty
percent comes from private companies. Pearl of the Orient has a great reputation in the
community because of the high quality of the services they provide.
The current government fund’s scam and the slashed in government budgets have
materially diminished the sources of funding available to both national and local
governments and SUCs. Consequently, contracts between Pearl of the Orient and the
said agencies that were once “automatic renewals” have become less certain. Contracts
that are renewed often times have provisions reducing the reimbursed amounts for
service units (health care services provided to clients). The nonrenewal of some
contracts and the lower reimbursement amounts on new contracts is beginning to
reduce working capital to dangerously low levels.
Pearl of the Orient has a line of credit with a local bank in the amount of P5,000,000.
The current economic circumstances have resulted in Pearl of the Orient needing to
utilize the entire P5,000,000 line of credit with little hope of being able to pay down the
debt in the next year. Pearl of the Orient is using the line of credit as a source of
permanent financing and Matt realizes that if the line is not renewed, an immediate
liquidity crisis would result. The bank requires that the line be reviewed twice yearly
which entails providing them with the most recent financial statements. The six month
review is next week.
Matt reports to the Chief Financial Officer of Pearl of the Orient, Yolanda Gomez. Matt
has quickly learned that Yolanda is a hard driving, focused executive and has
aspirations to become the Chief Executive Officer sometime in the future. She tolerates
no dissention and views discussing issues as a waste of time because of her certainty
of being correct.
Ms. Gomez is concerned that the current financial statements will not be satisfactory to
the bank. The statements reflect a fast deterioration of working capital approaching a
1:1 ratio with current liabilities needing to be paid in the next thirty days but amounts
due from government agencies and SUCs expected to be received in the next 60-120
days. The operating statement is currently showing an operating loss. Ms. Gomez is
concerned that the statements could cause the bank to increase the interest rate on the
line of credit or cause the line of credit to be cancelled. The cancellation of the line of
credit would bring on such a liquidity crisis that it is doubtful that Pearl of the Orient
could remain a going concern.
Ms. Gomez has approached Matt to discuss the current financial situation and current
financial statements. She indicates to Matt that she believes that certain modifications
could be made to the financial statements which would show Pearl of the Orient in a
more favorable financial and operating position. She tells Matt that it is almost certain
that Pearl of the Orient will receive a P7,500,000 grant in the next 4-5 months from the
Department of Health due to the expected increase in the required health care services
as a result of the continuous spread of corona virus. Ms. Gomez believes that this will
eliminate the organization’s liquidity problem.
Matt knows that he and the CFO must sign a representation letter accompanying the
financial statements going to the bank. The letter, in essence, states that the
accompanying financial statements, to the best of their knowledge and belief, present
fairly the Pearl of the Orient’s financial position and the operating results in accordance
with generally accepted accounting principles. Matt questions the CFO about the
implication of “modifying the statements” and signing such a letter. She emphatically
states that this type of “earnings management” is very common in the different sectors
of the economy. When survival of an entity is at stake such financial statement
modification is the only thing an entity can do. “After all, where is your loyalty, to the
bank or to our clients who depend on the healthcare services we provide? Any
adjustments you make to the books will be reversed once we receive the P7,500,000
grant and no one will know about the “modified” financial statements but you and me.
Also, our audit is over six months away.”
Matt knows the dire consequences of his telling the CFO he will not modify the financial
statements or sign a letter accompanying the financial statements. Matt decides to
postpone consideration of the long-term structural cost issues and he begins to think
about how he could modify the accrual based financial statements.
His ideas are beginning to evolve:

1. Accrue revenues not yet due from the different government agencies and SUCs.
His rationalization is these items are under a contract and they will be due once
Pearl of the Orient provides the services.
2. Exclude certain accrued expenses using the rationalization that these items do not
need to be paid at this time.
3. Change the estimated useful life of the Company’s building from 25 years to 50
years and certain equipment from 5 to 10 years.
4. Reclassify certain noncurrent assets as current and classify certain current
liabilities as noncurrent.
Matt believes that many times such classification is somewhat subjective and he is
merely using his judgment.
Matt is pleased with his ideas because these modifications will improve both the
working capital picture as well as improve the operating results of Pearl of the Orient.
Yet, he is troubled that he has been asked by the CFO to change the financial
statements so that Pearl of the Orient looks favorable to the bank. He is equally
concerned that he will need to provide his signature to the letter accompanying the
statements. Matt decides to leave the office and head home to discuss these issues
with his wife Alyssa.
Matt and Alyssa prepare the children’s dinner and ready them for bed. Once Alyssa and
Matt have time alone, Matt describes the events of his day. He describes the
conversation with Ms. Gomez. He outlines Pearl of the Orient’s financial problems and
the liquidity and going concern crisis that will be faced if the bank does not renew the
line of credit. He tells Alyssa that he must modify the statements in order for the
organization to have a reasonable chance of a renewed credit line. He discusses his
professional and ethical responsibilities to the profession as well as his responsibility to
the general public. He asks for Alyssa’s perspective on the dilemma he faces.
Alyssa does not hesitate to offer her opinion. “Shouldn’t you consider the clients of Pearl
of the Orient first? Many of those people would receive no health care without Pearl of
the Orient and some of them could even die. It seems to me that temporarily adjusting
the financial statements is a small price to pay to keep the services of Pearl of the
Orient available to your clients. Face it Matt, professional ethics always sounds
somewhat attractive in the classroom but what about the real world?”
After a pause, Alyssa continues. “I think that you also have to consider your family. You
know, if you refuse to change the financial statements, Ms. Gomez will probably fire you
immediately and Pearl of the Orient will not pay severance. Where will you find a job?
We have had a hard time financially since I have been out of work. How would we
manage if you lost your job? Are you prepared to risk your family’s well-being?”
Matt ponders the events of the day. “Ethical issues are much more difficult in reality
than in the classroom-I never dreamed I would be placed in such a difficult position.”
Required:
 Using the six-step approach, resolve the ethical dilemma. (see attached format)

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