TIF 4-1 Ethics in Action In the course of implementing the new costing system, t
ID: 2541804 • Letter: T
Question
TIF 4-1
Ethics in Action
In the course of implementing the new costing system, the controller realized that the company's current period GAAP net income would increase significantly if the new product cost information were used for inventory valuation on the financial statements. The controller has been under intense pressure to improve the company's net income, and this would be an easy and effective way for her to help meet the company's short-term net income goals. As a result, she has decided to use the new costing system to determine GAAP net income.
Explanation / Answer
Response to Question 1
Based on the information provided in the question, it seems that because more accurate cost information is now available to the company, the inventory valuation under the new system would be higher than the valuation under the old system, the overall profitability will increase, because a higher quantum of costs would now be allocated to inventory rather than cost of goods sold. This is likely to improve the gross profit margin and consequently, net profit. Therefore, on account of higher cost allocation to inventory, the profit of the company will increase.
Response to Question 2
The framework of GAAP prescribes that the financial statements are expected to provide a true and fair view of any entity’s operating results and statement of financial position.
Preparation of financial statements often require significant use of estimates, one of he areas of estimate being inventory valuation, where costs needs to be allocated and even the recoverable value needs to be determined for inventory items in some cases.
In the given case, implementation of a new costing system leads to a change in inventory valuation. In the given case, the finance controller can be considered to be acting ethically if:
Finally, GAAP provides some safeguards, typically in terms of disclosures in cases where such methodologies impacting the financial statements are changed and have a significant impact on the financial statements.
Provided all the pointers above are duly satisfied, it can be said that the finance controller is acting ethically.
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