| Course | ACC 423 Detection/Prevention Fraudulent Financial Statements |
|---|---|
| Module | Module 3 |
| Paper type | undergraduate assignment analyzing expense deferral and reserve manipulation |
| Length | About 1,010 words, 6 pages |
| Format | APA 7 student paper |
| School | Southern New Hampshire University |
| Program | BS Accounting |
| Updated | October 2026 |
Free sample paper for ACC 423 Module 3
Making Costs Disappear: Capitalized Start-Up Costs, a Released Warranty Reserve and a Stale Obsolescence Allowance
[Student Name]
Southern New Hampshire University
ACC 423: Detection and Prevention of Fraudulent Financial Statements
Module Three Assignment
[Instructor Name]
[Date]
The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.
Making Costs Disappear: Capitalized Start-Up Costs, a Released Warranty Reserve and a Stale Obsolescence Allowance
Introduction
The revenue schemes in Module Two were not the only reason the water heater maker's fourth quarter looked strong. Its gross margin also rose a full point, from 25 to 26 percent, while competitors reported flat margins, and its operating expenses grew more slowly than sales. A review of the year-end close found three practices that reduced reported costs. Each depends on judgment, which makes each easy to defend and hard to detect without the company's own operating data. Healy and Wahlen (1999) note that estimates and accrual choices are the main tools of earnings management because they require judgment that outsiders cannot easily check. This assignment examines each, measures its effect and identifies how it could be found.
Practice 1: Capitalizing Start-Up Costs
In the fourth quarter the company launched a heat pump water heater line in a converted section of its Tennessee plant. It recorded $6.8 million of costs as construction in progress and then as equipment: $2.9 million of trial production runs, $1.6 million of operator training, $1.4 million of units scrapped during calibration and $0.9 million of consultant fees for process tuning.
GAAP requires start-up costs, the one-time activities of opening a new facility or line, to be expensed as incurred. The equipment itself, the heat pump assembly cell and tooling, was properly capitalized separately at $11.2 million. The $6.8 million is not equipment; it is the cost of learning to use it. Because the line was placed in service in November, the company had also begun depreciating the $6.8 million over ten years, recording about $0.1 million. The correction expenses $6.8 million and reverses the depreciation, for a net reduction in pretax income of $6.7 million.
Practice 2: Releasing the Warranty Reserve
The company accrues warranty cost as a percentage of sales. For five years the rate was 2.4 percent, close to actual claims experience. In December the CFO lowered it to 1.8 percent, citing improved product quality. The claims data say otherwise: claims per thousand units sold rose from 21 to 26 during the year after a supplier changed the design of a pressure relief valve, and the company has opened a field campaign for affected units.
Applied to the year's $410 million of sales, the lower rate reduced warranty expense by about $2.5 million. Because warranty cost is included in cost of goods sold, the release also explains about 0.6 points of the gross margin increase. A change in estimate is legitimate when new evidence supports it, but here the evidence pointed the other way. The correction restores the 2.4 percent rate, increasing expense by $2.5 million, and further analysis of the valve problem may require more.
Practice 3: An Unchanged Obsolescence Reserve
The company discontinued four gas water heater models in September to meet new efficiency standards. It held $2.1 million of those units at year end and has been selling them to a liquidator at about 60 percent of cost. Yet the obsolescence reserve stayed at $0.9 million, the same as the prior year, when no models had been discontinued. Inventory cannot be carried above what it will bring in, so the discontinued units should be written down to roughly $1.26 million, a write-down of $0.84 million, in addition to the existing reserve for slow-moving parts. Reasonable judgment might place the additional write-down between $0.8 and $1.4 million; the estimate here uses the liquidator's actual price.
Table 1. Effect of Corrections on Pretax Income (millions of dollars)
| Practice | Correction |
|---|---|
| Start-up costs capitalized, net of depreciation reversed | (6.7) |
| Warranty accrual restored to 2.4 percent of sales | (2.5) |
| Write-down of discontinued gas models to net realizable value | (0.8) |
| Other small reserve adjustments identified in the review | (0.5) |
| Total reduction in pretax income | (10.5) |
Why Judgment Accounts Are the Favored Tools
All three practices share a feature: each turns on a judgment that management is entitled to make. Someone must decide what part of a new line's cost is equipment, what warranty rate fits future claims and what discontinued inventory will bring. Auditors and investors usually defer to those judgments unless evidence contradicts them, and that deference is what makes these accounts attractive to a company under pressure. The defense is to anchor each judgment in data the company already collects. Here the plant's work orders separated tooling from training, the service department tracked claims by model and the sales system recorded liquidation prices. In each case the accounting departed from the company's own records, which is the strongest evidence that the change was made to reach a number rather than to reflect new information.
Signals That Would Reveal the Practices
Each practice left signals. Capital spending rose 38 percent while plant capacity rose about 12 percent, and the new equipment's cost per unit of capacity was well above the vendor's quotes. The warranty expense ratio fell while claims per thousand units rose, a direct contradiction visible in the company's own service data and easy to chart for an audit committee. And inventory days increased even as sales grew, concentrated in finished goods. Studies of SEC enforcement targets report that such companies used exactly these accrual choices and carried unusually large accruals in the years before discovery (Dechow et al., 1996). Beneish (1999) built two of these signals, asset quality and gross margin changes, into his model for detecting manipulators, which Project One applies to this company.
Conclusion
Three judgment-based practices, capitalizing start-up costs, cutting the warranty accrual against the claims evidence and leaving obsolete inventory unreserved, overstated pretax income by about $10.5 million. Together with the revenue schemes in Module Two, they turned a year that missed guidance by a wide margin into one that appeared to beat it. Each would have been revealed by comparing the accounting with the company's own operating data. The corrections also have a future effect: expensing the start-up costs now removes about $0.7 million a year of depreciation from the next ten years, so part of this year's overstatement would otherwise have been charged gradually, hiding its origin.
References
Beneish, M. D. (1999). The detection of earnings manipulation. Financial Analysts Journal, 55(5), 24-36. https://doi.org/10.2469/faj.v55.n5.2296
Dechow, P. M., Sloan, R. G., & Sweeney, A. P. (1996). Causes and consequences of earnings manipulation: An analysis of firms subject to enforcement actions by the SEC. Contemporary Accounting Research, 13(1), 1-36. https://doi.org/10.1111/j.1911-3846.1996.tb00489.x
Healy, P. M., & Wahlen, J. M. (1999). A review of the earnings management literature and its implications for standard setting. Accounting Horizons, 13(4), 365-383. https://doi.org/10.2308/acch.1999.13.4.365
What the ACC 423 Module 3 instructions ask for
The Module Three assignment in ACC 423 usually presents a company's expense, asset and reserve accounting and asks you to identify manipulation. Expect schemes such as capitalizing costs that should be expensed, extending useful lives, releasing or failing to build reserves, and failing to write down impaired assets or obsolete inventory. For each, state the rule that governs the item, explain how the company's treatment departs from it, quantify the effect on income and assets, and identify the analytical signals and documents that would reveal it. Distinguish a reasonable change in estimate, supported by evidence, from one made to reach a target, because the same entry can be either depending on its support.
How this ACC 423 Module 3 expense and asset manipulation assignment example is built
The sample examines three items. The company capitalized $6.8 million of trial production runs, operator training and scrapped units on a new heat pump line as equipment, though start-up costs must be expensed. It cut its warranty accrual from 2.4 to 1.8 percent of sales, releasing about $2.5 million, even though claims per thousand units rose after a supplier changed a valve. And it kept its inventory obsolescence reserve at $0.9 million despite $2.1 million of discontinued gas models it now sells at a loss. The corrections reduce pretax income by about $10.5 million. Signals include rising capital spending with flat capacity, a falling warranty rate with rising claims and slower-moving inventory.
Where the ACC 423 Module 3 rubric puts the points
Rubrics for the ACC 423 expense manipulation assignment typically score identification of each scheme, application of the correct accounting rule, quantification, the warning signals and the distinction between legitimate estimates and manipulation. Top papers cite the specific rule, such as the requirement to expense start-up costs or to base warranty accruals on claims experience, and support the quantification with stated assumptions. Graders reward analysis that uses the company's own data, such as claims history, to show that a change in estimate lacked support. Common deductions include treating every capitalized cost as improper, ignoring the deferred effect of capitalized costs on future depreciation and identifying a reserve problem without measuring it.
ACC 423 Module 3 help: the mistakes that cost points
Expense manipulation papers most often go wrong by declaring an estimate fraudulent without testing it against evidence, or by quantifying only one side of the effect, for example reversing capitalized costs without removing the depreciation already taken on them. Another common gap is forgetting that reserve releases improve gross margin, which is one of the signals. If your case involves extended asset lives, avoided impairment charges or cookie-jar reserves built in good years and released in bad ones, the same structure of rule, departure, amount and signal applies and can be built from your facts. Use the company's own operational data wherever the case provides it.
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ACC 423 Module 3 questions, answered
Where can I find a free ACC 423 Module 3 expense manipulation sample?
This page includes a full ACC 423 Module 3 assignment analyzing improper capitalization and reserve manipulation at a water heater maker.
Can start-up costs be capitalized?
Generally no. Costs of start-up activities, such as training, trial runs and initial inefficiencies, are expensed as incurred under GAAP, even when a new line is being launched.
How should a warranty reserve be estimated?
From expected future claims on products already sold, based on historical claim rates adjusted for known changes, such as a component defect.
What is a cookie-jar reserve?
A reserve deliberately overstated in a good period so it can be released later to boost earnings, or a reserve released without support to meet a target.
What signals suggest improper capitalization?
Capital spending that rises faster than capacity, falling expense ratios without operational reasons and growth in asset accounts described vaguely, such as other or deferred costs.