Ethics Case BYP6-7 R. J. Graziano Wholesale Corp. uses the LIFO method of invent

Question

Ethics Case BYP6-7 R. J. Graziano Wholesale Corp. uses the LIFO method of inventory costing. In the current year, profit at R. J. Graziano is running unusually high. The corporate tax rate is also high this year but it is scheduled to decline significantly next year. In an effort to lower the current year's net income and to take advantage of the changing income tax rate, the president of R. J. Graziano Wholesale instructs the plant accountant to recommend to the purchasing department a large purchase of inven- tory for delivery 3 days before the end of the year. The price of the inventory to be purchased has doubled during the year, and the purchase will represent a major portion of the ending inventory value. Instructions (a) What is the effect of this transaction on this year's and next year's income statement and income ry costing, would the pres- (c) Should the plant accountant order the inventory purchase to lower income? What are the ethical tax expense? Why? ident give the same directive? implications of this order?

Explanation / Answer

a) The company follows LIFO method.

Indications given are,Income is HIGH....Tax rate is HIGH...Tax rate in next year is low.

So, as a common man thinks to reduce his tax liability, the company should think to defer income to be taxed in next year as tax rate is low in next year.

The president purchased huge inventory during last days of year.Purchase price is also double.

Result:

So purchases value increases, and stock also increases.

for example,

During the year, A 's purchases were 3 pens worth 50 each.

Sales two pens for 110 each. Closing stock is one pen $ 50....Profit=sales +c/s-O/s-purchases=220+50-(50*3)=$ 120.

Tax would be 50% say....$ 60.

after year end purchases

say, he purchased two pens additionally at year end for $ 100 each, and sold one pen out of that for $ 110 (since, he is following LIFO, latest one is sold first)....Stock is one pen worth $ 100.

When we combine, full yr Income statement is,

   Sales          =2 pens=    220

(-)purchases=150+200=     (350)

(+)Closing stock= (50*2)+100=200

Profit=220+200-350=70....

Tax @ 50% is 35.....So, we reduced tax by 25$ just by doing purchase transaction.

Next year:

Opening stock will be 200 (3 pens), if sold all 3 pens for 110, and no purchases...

then profit=330-200=130... Tax rate= 20%(say, since it is much lower, as per question)

Tax=130*20/100=26

If, year end purchases not done in year 1

Then in yr 2, Opening stock=1 pen=50......sales= 3 pens =330

            so, purchased 2 pens for 100 each=200...

Profit=330-200-50=80....Tax=16

Impact in LIFO

b) FIFO followed:

If FIFO method is followed, definitely he will not give the same directive, since if he made more yr end purchases,

entire purchases will remain in stock...so, both debit and credit amt will be equal, leaving no change in income in yr 1, hence there will be no change in tax in yr 1.

In yr 2, the value of opening stock is higher due to yr1 end purchases. so, income in yr 2 will be lower. Which is not desirable as tax rates are significantly lower in yr2.

So, from above we can conclude that, the principal will not give the same directive if FIFO is followed.

C) No, Ethically it is not correct for the accountant to order purchases to lower income.

The business should happen systematically, on its own..It should not be influenced by anyone. Many consumers, investors have faith in the businesses, they invested their hardearned money beleaving the practices of business. They should not be mislead. Boosting revenues by increasing sales, or increasing purchases for reducing taxes etc., is not justified...

The business can succeed by all such activities in short term, but it cannot succeed in Long term.. Any fault will be found out in future.. Also, it is not a good sign to any industry. The economy creates its own standards, one cannot/should not manipulate them.

There were several companies in the world, which does this types of manipulations and got liquidated in later years... One example of such is, SATYAM group, Kingfisher group in INDIA.

So, For protecting the interests of the investors and customers theses activities should not be allowed. Also, several governments impose severe punishments to those who doesn't ether to the ethical standard.

Hope it helps,

Thank you.

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