Question

Ethics Case 9-11 Overstatement of ending inventory Damville Bonders is a wholesale beverage company, Danileve the inventory method to determine the cost sending inventory Ending inventory quantities are determined by a physical For the accounting Sear and December 31.-12. ending inventory was originally de m ed to be 0.265 However, on January 17. 2022. John Howard, the company's controller, discovered an emr in the ending inventory count. He determined that the correct ending inventory amount should be 52. 0LXO. Danville is a privately owned corporation with cant financing provided by a local bank. The bank requires annual audied financial statements as a condition at the laun. By January 17, the auditors had completed their review of the financial statements which are scheduled to be issued on January 25. They didney discover the inventory error John's first reaction was to communicate his finding to the auditors and revise the financial statements before they are issued. However, he knew that his and his fellow wollen proti shunt plans we based on annual petux earnings, and he is uncertain what effect the error correction would have on p at cup Required: 1. What is the effect of the inventory errur oa preta camings 2. How would correcting the error affect employee bonuses 3. If the error is not corrected in the current year and is discovered by the auditions during the following years modit, how will it be reported in the company's mancial statement 4. Discuss the ethical dilemma John Howard faces

Answer 1

1- What is the effect of the inventory error on pretax earning?

Answer-

Given wrong inventory valuation                             = $ 32,65,000

Given correct inventory valuation = $ 26,00,000

Difference in the Inventory                               = $ 6,65,000

The Difference shows the high valuation of inventory by $ 6,65,000 which impact on the profit earned by the company, shows wrong profit by same ($ 6,65,000) because closing stock directly impact to increase the profit or to decrease loss.

So, pretax earnings are shown maximizing by $ 6,65,000.

2- How would correcting the error affect employee bonuses?

Answer-

If we correct the error of high valuation of closing stock by $ 6,65,000 , the total amount of employee bonus will be less by the same amount ($ 6,65,000) as compared to previous estimated employee bonus.

3- 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 statement?

Answer-

If the error is not corrected in the current year and is corrected in the following year’s company’s financial statement, the treatment is given in the below-

Statement of Profit or Loss

Particulars	Following Year (Amount)		Remarks
Revenues		(A)
Cost of Goods Sold-
Opening Stock	X		Opening stock =Last Year’s Closing stock (overvalued by $ 6,65,000)
Add : Purchases	Y
Less : Closing Stock	Z		Correct Closing Stock in this year
Cost of Goods Sold-	(X+Y-Z)= B	(B)	Cost of Goods Sold is overvalued due to overvalued opening stock c/f from last year’s closing stock
Gross Profit		(A-B)	Gross Profit is undervalued by $ 6,65,000 due to overvaluation of opening Stock

In the above data we assume that current year value of the below -

Revenues                           =A

Opening Stock                   =X

Purchases                           =Y

Closing Stock                      =Z

So, There should no need to be special adjusted in the current years retrospective effect. Following year’s profit automatically adjusted last year overvalued profit.

4- Discuss the Ethical Dilemma John Howard Faces.

Answer-

John Howard faces the below Ethical Dilemma-

1. John has showed to Overvalued profit in the current year,
2. He has showed overvalued profit to decide wrong employees bonus,
3. Current assets are overvalued in the current year financial statement,
4. Auditor will think that he has showed overvalued profit to show the company’s financial position sounds good,
5. Auditor will think that he has showed overvalued profit to take the high approval of loan by presenting overvalued profit,
6. The company share value is increased by showing overvalued profit,
7. Wrong information has been passed to the company’s shareholders and,
8. Paid excess tax on overvalued profit.