Question

You own a management consulting business and often provides advice to your friend John, the CEO of a publicly traded company. In a meeting with investment analysts at the beginning of the year, John predicted the company's earnings would grow 20% during the year. Unfortunately, sales were flat during the year, and John concluded within two weeks of the end of the fiscal year that it would be impossible to report an increase in earnings as large as predicted without taking extreme action. As a result, John ordered that whenever possible, expenditures should be postponed to the new year, canceling orders with suppliers, delaying planned maintenance and training, and cutting back on advertising and travel. Additionally, John ordered the controller to carefully review all selling and administrative (period) costs, and reclassify as many as possible as product costs. The company is expected to have substantial inventory on hand at the end of the year.

Required:

In your post, address the following questions:

1. Why would reclassifying period costs as product costs at the end of the year increase the current period's reported earnings?
2. Do you believe that John's actions are ethical? Why or why not?

Answer 1

1)

Product cost are one which are directly linked to the products sold while period cost are like expenses which occur irrespective of units sold. Since they are expecting lesser sales by converting period cost to product cost it will increase the ending inventory by which cost of goods sold decreases adn profit will increase as on books in Income statement.

2)

It is not ethical if you see it exactly but it is done by all and it can be done as per accounting standards.If we have valid reasons then auditors will not have any issues.It is just postponing the expenditure and we are not hiding the results.