Question

You are a CPA and serve as an independent director on a manufacturing company’s audit committee. The board of directors assigned you to examine the company’s managerial accounting system. You found several issues listed below:

1. The company classified an executive’s salary as manufacturing costs. The executive is in charge of the company’s production.

2. Based on the company’s budgeted production and actual sales and purchases, the company had substantially overproduced the products during the period.

3. The costs of direct materials increased in the period. The company switched to FIFO from the weighted average cost method in the period.

4. The company overestimated the percentage of completion of ending work in process inventory with respect to conversion costs.

5. The company substantially cut advertising expenses in the period.

6. The company has different products. The sales revenues are mainly attributable to the sale of high-volume products. The company switched to ABC from the traditional approach in applying manufacturing overhead in the period.

Required: Discuss the implications of these issues for the company’s external financial reporting.

Answer 1

Following are the implications on the company's external financial reporting for the below mentioned issues :-

1 . Only those costs which are incurred on producing a product is shown as manufacturing cost. Accordingly salary paid to executive cannot be shown and correction should be made in financial statements.

2 . Company has overproduced they product from what it has budgeted will not have any implications with respect to external financial reporting as it is a common business phenomenon.

3. Company has switched from weighted average method of cost to FIFO, it amounts to change in accounting policy, accordingly, proper disclosure of change in accounting policy as well as it's financial impact should be disclosed in the notes to financial statements as disclosure.

4 . Company overstated percentage of completion on work in inventory , accordingly corrections should be made in financial statement

5 . Company has made substantial cut in it's advertising .expenses will not going to have any implications on the financial reporting

6 . Since company has switched to ABC from traditional reporting of manufacturing overhead , a statement with this regard should be made .