Danville Bottlers is a wholesale beverage company. Danville uses the FIFO invent

Question

Danville Bottlers is a wholesale beverage company. Danville uses the FIFO inventory method to determine the cost of its ending inventory. Ending inventory quantities are determined by a physical count. For the fiscal year-end June 30, 2016, ending inventory was originally determined to be $3,265,000. However, on July 17, 2016, John Howard, the company's controller and a CPA, discovered an error in the ending inventory count. He determined that the correct ending inventory amount should be $2,600,000 Danville is a privately owned corporation with significant financing provided by a local bank. The bank requires annual audited financial statements as a condition of the loan. By July 17, the auditors had completed their review of the financial statements which are scheduled to be issued on July 25. They did not discover the inventory erroir. John's first reaction was to communicate his finding to the auditors and to revise the financial statements before they are issued. However, he knows that his and his fellow workers' profit-sharing plans are based on annual pretax earnings and that if he revises the statements, everyone's profit-sharing bonus will be significantly reduced. Required: Why will bonuses be negatively affected? What is the effect on pretax earnings? What journal entry should be made in the current year to correct the prior year inventory error? If the error is not corrected in the current year and is discovered by the auditors during the following year's audit, how will it be reported in the company's financial statements? Discuss the ethical dilemma John Howard faces. Based on the discussion in the case and the AICPA's Code of Professional Conduct, which principles should John Howard use in addressing this ethical dilemma (choose 2)? Briefly explain how each principle is related to the ethical issue and how the guidance provided by the AICPA Code of Professional Conduct should be applied to address the ethical issue 1. 2. 3. 4. 5.

Explanation / Answer

1. As ending inventory is overstated the cost of goods sold will be lower and the income margin will show an increased trend by which pretax earnings also go up indirectly.

2. Journal entry to correct purchasing error: Debit cash account by $ 665,000 (3265,000 - 2600,000) and credit inventory account by the same amount.

Journal entry to correct balance sheet error: Debit inventory account by $665,000 and credit retained earnings by the same amount.

3. It should be mentioned in the balance sheet some or the other way like mentioning it in the foot note or say additional information as it increases the cost of goods sold and makes the company look less profitable.

4&5. According to the AICPA's code of professional conduct, Misstatement can arise due to fraud or error. Here in the case of John Howard, He and the auditor has to physically inspect the inventory once again through observation, records and assess the probability of missing items or the systematic records and thereby finding out the overstatement cause.

But if the person and the auditor is reckless about this the profits show a higher margin which will later be ignored and this leads to illegally influences the investors or shareholders and both should bare the consequences induced by the accounting standards of AICPA

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