Ethics Case 19-3 Stock ptions 019-2 @ You are in your second year as an auditor

Question

Ethics Case 19-3 Stock ptions 019-2 @ You are in your second year as an auditor with Dantly and Regis, a regional CPA firm. One of the firm's long-time clients is Mayberry-Cleaver Industries, a national company involved in the manufacturing, marketing, and sales of hydraulic devices used in specialized manufacturing applications. Early in this year's audit, you discover that Mayberry-Cleaver has changed its method of determining inventory from LIFO to FIFO. Your client's explanation is that FIFO is consistent with the method used by some other companies in the industry. Upon further investigation, you discover an executive stock option plan whose terms call for a significant increase in the shares available to executives if net income this year exceeds S44 million. Some quick calculations convince you that without the change in inventory methods, the target will not be reached; with the change, it will. Required: Do you perceive an ethical dilemma? What would be the likely impact of following the controllers suggestions? Who would benefit? Who would be injured? Page 1151

Explanation / Answer

Accounting for inventory by LIFO means issuing inventory to production at the latest prices(Last-in-First-Out)--which means COGS will be at the latest higher prices ,than what were bought earlier. So, the gross profit & finally the net profit will be lower. With FIFO, Just the opposite, is issues are at older prices, so COGS is less costlier. So, the gross profit & finally the net profit will be higher. So, converting from LIFIO to FIFO will projcet more profits which qualify to disburse stock options to the Company's executives, as announced. 1..In effect, if following FIFO, is prevalent in the industry, there is nothing UNETHICAL about changing the method,. On the way, the stock-option plan is also satisfied. 2..The likely impact is as dealt above,gross profit & net profit will be higher ,on which is based the stock incentive plan. 3. Beneficiaries 1.will be the company executives--who will get the option to purchase shares and thus the likelihood to participate and own the company ,on exercising the options. 2. Current Earnings per share will increase to the shareholders. 4.. Those injured will be: the existing shareholders who may have to share ownership with these executives, in future, when the latter opt to exercise the options conferred.

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