Question

Symington and Cribbs (S&C) is a sporting goods distributor. S&C uses the FIFO inventory method to determine the cost of its ending inventory. Ending inventory quantities are determined by a physical count. For the fiscal year-end December 31, 2013, ending inventory was originally determined to be $67 million. However, in early January of 2014, the company's controller, Amy Grant, discovered that an error was made in the inventory count. The correct amount of ending inventory should be $87 million. The auditors did not discover the error and the financial statements are scheduled to be issued on February 26, 2014. S&C is a public company.
Amy's first reaction was to communicate her finding to the auditors and to revise the financial statements before they are issued. However, she knows that this was a very good year for the company with profits far exceeding analysts' expectations. If the error is not corrected this year, it will self-correct next year as long as 2014 ending inventory is correctly stated. This will help future 2014 profits. On the other hand, her fellow workers' profit sharing plans are based on annual pretax earnings and if she revises the statements, everyone's profit sharing bonus will be higher this year.

Required:

1. Is Amy correct by stating that the error will self-correct next year as long as 2014 ending inventory is correctly stated? If the error is not corrected in the current year, what will be the effect on 2013 and 2014 income before tax?
2. Discuss the ethical dilemma Amy faces.

At least 350 words and one reference.

Answer 1

1. Yes, it is obvious that Amy is correct. If the error is not rectified in 2013, ending inventory will be $20 (67-87) understated. This will cause cost of goods sold to be $20 (67-87) million overstated and income before tax to be $20 (67-87) million understated. However, since beginning inventory for 2014 will be $20 (67-87) million overstated, cost of goods sold will be overstated and income before tax will be $20 (67-87) million understated. This error would cause an income shift from 2013 to 2014.

2. The ethical dilemma faced by Amy includes, "Should Amy recognize her obligation to disclose the inventory error to S&C shareholders, auditors, and taxing authorities or hide it from everyone and remain quiet thus enabling the company to manage its earnings and shift $20 (67-87) million in before tax profits to the following year?" If Amy remains quiet, and other employees will receive lower year-end bonuses this year, but higher bonuses next year. However, if eventually it is discovered by the auditors in 2014, this will require the company to restate the 2013 financial statements to reflect the correct inventory amount.