Question

Case 3:

Each student will provide considerations to a given scenario related to:

Earnings Management

You are the accountant for the South-Western Division of HiValue Grocery Stores. Late in December, Kelly Cholak, the CEO of the division, stops by your office and says, “I have a couple of questions. I recently received a report from the head office on the first 11 months of the year. We are not doing as well as we budgeted, and they are not happy with the gross profit we have earned. But the good news is that I just got off the phone with a big supplier who has excess inventory and could sell us enough of their products to last us three months.

Then I remembered we have a perpetual inventory system and that you use that funny LIFO  inventory method where you play with such confusing numbers. Will the purchase increase cost of goods sold, because that would only make us look worse? Alternatively I thought we might be able to either switch to  the FIFO method OR I thought that we could delay this purchase until after January 1, and we would recognize some of those profits from liquidation of inventory and make ourselves look good for the year’s results.  Give these issues some thought and let’s have a drink after work today to discuss them.”

Required:  From financial reporting objectives of financial reporting, how would you reply to Kelly?

Answer 1

From financial reporting perspective and on an ethical perspective my reply to the CEO will be as follows,

We cannot change the methods of accounting as per our wish in order to increase the revenue or else to decrease the Expenses so that the net income would be increased. Making look good the company position while it is not actually good. It is violating the principle of consistency.

And also thinking in an ethical manner, it is not in favour of the intended users of financial statements.