I need help answering questions A,B,C,D. L Co. has not been very profitable for

Question

I need help answering questions A,B,C,D.

L Co. has not been very profitable for the past three years. Additionally, a recently ousted manager purchased a substantial quantity of inventory earlier this year...inventory whose customer desirability has waned to some extent. As such, the inventory value has declined below its cost and two methods of handling the write-down are being discussed: showing the amount of the write-down ($3,000,000) as a line item loss on the income statement and showing the loss as part of cost of goods sold. Both methods are GAAP What is the ethical accounting issue in this situation? (1 pt.) Considering the qualitative characteristics of accounting as well as basic accounting concepts, discuss pros and cons of using (1) the loss method and (2) the CGS method. (3 pts.) What other information might be useful in making the decision as to how the loss will be recognized on the income statement? (2 pts.) What method would you choose and why? (1 pt.) a. b. c. d.

Explanation / Answer

a. The ethical accounting issue in this situation pertains to conflict of interest that has arisen on account of excessive purchase of inventory. The Management is unable to decide on how to account the decline in the inventory value.

b. Pros of the loss method would include better presentation and accounting of the decrease in inventory value as the users of financial statments will become aware of the fact and there would be better transparancy in the Financial Statments. Cons of the loss method would include decrease in retained earnings thereby leading to a decrease in the shareholder's equity section of the balance sheet.

Pros of the Cost of Goods Sold method would include burying the loss amount directly into Cost of Goods Sold account thereby hiding the loss on account of inventory from being disclosed on the face of the Financial Statements. This would help avoiding discomfort on the users of financial statements part. Cons of Cost of Goods Sold method would be the violation of matching principles as there would be no corresponding income that would be charged against the cost.

c. The materiality of the amount of loss, if the amount is significant and high, the loss method would be a recommended course of action whereas if the amount is negligible, the amount could be recognized in the Cost of Goods Sold Account.

d. Loss method would be the right choice as it ensures transperancy in the financial statements as well as the user's who take decisions based on the financial statments.

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