You are in your second year as an auditor with Jones and Johnson, a regional CPA
ID: 2569988 • Letter: Y
Question
You are in your second year as an auditor with Jones and Johnson, a regional CPA firm. One of the firm’s long-time clients is ABC Corporation, a national company involved in the manufacturing, marketing, and sales of hydraulic devices used in specialized manufacturing applications. Early in this year’s audit, you discover that ABC Corporation has changed its method of determining inventory from LIFO to FIFO. Your client’s explanation is that FIFO is consistent with the method used by some other companies in the industry. Upon further investigation, you discover an executive stock option plan whose terms call for a significant increase in the shares available to executives if net income this year exceeds $44 million. Some quick calculations convince you that without the change in inventory methods, the target will not be reached; with the change, it will.
Required:
Do you perceive an ethical dilemma?
What would be the likely impact of following the controller’s suggestions?
Who would benefit?
Who would be injured?
Explanation / Answer
Last in first out (LIFO) is a method of inventory valuation, where materials received last will be issued first for the production. This is relevant incase of rising price, so that the production cost is very near to the current price.
First in first out (FIFO) is a method of inventory valuation, where materials received first will be issued first for the production. This is relevant incase of decreasing price, so that the ending inventory becomes very near to the current price.
Case: This is the case of increasing the net income, so that it can cross $44 million. In the present economic condition all over the world, prices are increasing for almost all the goods and services.
Net income = Total revenues – Total costs
If LIFO is followed the total cost could be high, causing lower net income.
If FIFO is followed the total cost could be low, since the material cost is in earlier lower price; it makes the net income high, because the gap between total revenues and total costs increases.
Ethic: There is a dilemma, since the change is made not because of corporation’s need but for the sake of personal benefits. The client explains in favor of change, because it is consistent; but the actual fact is to manipulate the net income. Therefore, this is not wise.
Impact: The suggestion should not be followed, since this is a malpractice. If it is approved, the company can go for more manipulation for the benefits of executives in future as well.
Benefits: The executives would be benefited by this change, because they can avail the stock option plan.
Injured: Shareholders could be injured, since they are provided manipulated information; moreover their shares of profits are distributed among the executives. These are all not good.
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