Question

Please help in answering these questions. Can you also include the accounts that are affected for the transaction that the CFO is suggesting? I need to write half a page for my answer. THank you!

Ethics AP6-5 Horizon Corporation manufactures personal computers. The company began operations in 2012 and reported profits for the years 2012 through 2019. Due primarily to increased competition and price slashing in the industry, 2020's income statement reported a loss of $20 million. Just before the end of the 2021 fiscal year, a memo from the company's chief financial officer (CFO) to Jim Fielding, the company controller, included the following comments: If we don't do something about the large amount of unsold computers already manufactured, our auditors will require us to record a write-down. The resulting loss for 2021 will cause a violation of our debt covenants and force the company into bankruptcy. I suggest that you ship half of our inventory to J.B. Sales, Inc., in Oklahoma City. I know the company's president, and he will accept the inventory and acknowledge the shipment as a purchase. We can record the sale in 2021 which will boost our loss to a profit. Then J.B. Sales will simply return the inventory in 2022 after the financial statements have been issued. Required: 1. Understand the reporting effect: What is the effect on income before taxes of the sales transaction requested by the CFO? 2. Specify the options: If Jim does not record the sales transaction requested by the CFO, what is the effect on total assets and income before taxes of the inventory write-down? 3. Identify the impact: Are investors and creditors potentially harmed by the CFO's suggestion? 4. Make a decision: Should Jim follow the CFO's suggestion?

Answer 1

Case History :

Company was doing excellent in position from 2012 to 2019 .Due to pricing challenge and touch competition , company losing bottom line , unfortunately in 2020, company recorded loss of $ 20 Mio . Before end of 2021 financial , CFO highlighted following Points :

1. Company still having Old large amount of Unsold Inventory .This is definitely a major concern for company . Inventory is piling up mean complete block of working capital ( due to high in Inventory cycle) . Also CFO most concern that Auditor will make additional provision on books as per Old Inventory ageing base report , which will disturb bottom line .
2. The resulting loss for 2021 will cause violation of our debt covenants

To avoid the above situation , CFO inform controller to ship half of old dated large Inventory to One company which is known to CFO , CFO wants to manipulate books and not to disclose correct picture to Stakeholders and unnecessary increase / boost Revenue . This is absolutely not acceptable as per prudent business , accounting policy ,

CFO insist to Controller to do fraud base accounting and boost up sales , reduce Inventory cost, subsequently after close of financial , issue credit note and rerun goods in Inventory . CFO wants to continue this practice till Old Inventory not sorted out . This is dangerous step and absolutely fraud step take by CFO .

Q1- As per CFO instruction –

Revenue will be boost by additional 50% of old Inventory movement.

No need to make 100% provision relates to Inventory Obsolesce, As per above scenario , CFO will go for max 5p% additional provision , which will also boost up bottom line

Over all , performance of 2021 bottom line will be good enough ( recovery from loss)

Q2- If Jim does not follow CFO instruction then asset side will be heavy by Inventory ( new + unsold old large ) . Jim has to make additional provision relates to Inventory obsolesce stock and it will impact Profit / loss account , also Pnl will be lower by revenue amount

Q3- Definitely Investor and creditors will potentially harmed by CFO’s decision because CFO does not want to highlight real picture to Stakeholders and if any person take decision on the basis of this ROSY picture then it will be more harmful

Q4- Jim definitely will not follow CFO view. He should not COOK financial number and wrong disclosure in the financial