Damaging Financial and Ethical Repercussions - Essay Example

? Capstone research project Question 1. Damaging financial and ethical repercussions The basic definition for an inventory write-down may refer to the formal recognition by a company that a portion of its inventory no longer has any significant value. In bookkeeping, this concept is supposed to be handled by having it charged in the company’s financial statements, when the asset’s carrying value can no longer be justified against its market value as being a fair value, and that the likelihood of receiving the asset’s book value mat at best be questionable. Alternatively, it may be handled by offsetting the balance of the inventory allowances in the books of account. In most cases, the inventory write-downs are small in value and in case of a larger value; the same is treated as a non-recurring financial loss. In the company’s income statement, the same can be reflected as an above-the-line expense. However, according to the IAS 1, companies are usually required to show separate disclosures for the inventory write-downs in the financial statements; taking into consideration that the inventory write-downs are items of near to the ground resolution. Accordingly, the International Accounting Standards 1 (IAS 1) requires that an organization provides sufficient information with regard to the issues that affects the significant events in the organization. The provided information should also be able to warrant a much better understanding of the company’s financial status. The greatest danger that lies for the company should it fail to include the write-downs of inventory in the financial statements is that it may lead to an overestimation of the earnings persistence by the company’s investors. Failure to do this is a great concern and as a partner in the audit process, I would seriously take this into consideration and seek to understand further basing on logical reasoning why the same was not included. Second, the failure to include the write-downs of inventory may lead to other significant effects of ethical and financial concerns to the audit process and the company in broad-spectrum such as, disproportionate compensations to the managers of the firm, frequent incidences in which fraud is concealed from the knowledge of the shareholders by the accounting and financial officers. Third, the failure may further lead to other unethical and of financial concern consequences such as the shareholders of the company losing faith and belief in the firm’s management ability to control its operations and finances. Additionally, it may be grievous for the firm to fail to recognize the inventory write-downs as the goodwill for the firm and its brand values may be lost as well. Finally, all accountants based on their ethical and professional training are required by the accounting code to report all of the financial occurrences of a company. As such, any accountant who fails to do this and reports less of the expected full financial report is violating the accounting standards as well as trust and ethics basis for the profession. The repercussions when found may be serious including termination and revocation of the accountant’s practicing certificate. 2. Recommendations to the CFO Since the firm is undergoing an IRS audit, it is prudent that the CFO becomes aware of the likely negative impacts of a civil fraud penalty on the corporation. An IRS civil fraud penalty is a penalty that usually equals 75% of the Federal tax that a corporation fails to pay and likely attributed to fraud (Wahlen, Bradshaw, Baginski & Stickney, 2010). However, since as a part of the examination of IRS, it has been discovered that the corporation’s write-downs were not authentic but, were simply comprehensive in the tax income for a subordinate tax computation, my recommendation as an audit partner would be that the CFO be aware of this fact, and avoid any negative impacts of the assessment. A gaze at the circumstances reveals that the inventory write-downs were not included in the financial statements; hence, the examination team from IRS may consult their frontline manager and report the same. If established by the Fraud Technical Advisor of IRS that the alleged is true, then the corporation may be faced with an imposition of a Civil Fraud Penalty of 75% of the tax that it owes the Federal tax body, an amount attributed to the fraud. Consequently, an interest may be collected on the unpaid amount until when the corporation fully settles it and the penalty. 3. Recommendations for internal control procedures to the CFO and the CEO Having considered the instances that there may be a likelihood of the corporation being faced by a Civil Fraud Penalty; I would like to put forth certain recommendations, as the audit partner that will be in line in ensuring that the corporation avoids the IRS penalty. If the Chief Executive Officer (CEO), and the Chief Financial Officer (CFO) implement these internal control recommendations, they may likely prevent such kind of any financial statement frauds. First, the corporation needs to establish and promote a whistleblower program that will detect any fraud instances in the corporation’s structure and make necessary alerts about the same to the administration. Second, the CFO and the CEO ought to make certain that there is a separation in duty from the accounting officer and the transacting officers for al its financial transactions. Second, there needs to be a creation of a right culture of honesty and transparency in the corporation as well as ensuring that there is fraud non-tolerance awareness in the organization. The third internal control modus operandi would be to ensure that the revenues of the corporation are matched with the cash flows. Above all, the two officers should ensure that the swings in both assets and liabilities of the corporation are properly analyzed. Finally, the corporation needs to enhance and encourage its staff to take up more training programs in accounting principles and regulations (Lymer & Oats, 2012). Alternatively, the Training and Education program should be set up in the premises by the corporation. CEO and CFO obligation The observance of these internal controls should become the main obligation and responsibility of the two officers, in regard to that which the accounting officers present in the financial statements. The signing of all the statements before the Board of Directors and the Auditors is their responsibility hence; they should owe the ultimate responsibility for any information contained in the statements. As such, any occurrence of financial fraud would be assumed to have got their endorsement. My strongest proposal to them would be that they strongly practice the internal controls so as to avoid any instances of financial statement frauds that may lead to penalties from occurring. Question 2: The negative results on stakeholders, and the financial statements, of an IRS audit that generates additional tax and penalties or the subsequent audits. In the event of an IRS examination that reveals civil fraud, there may be likely consequences to both the stakeholders and the financial statements themselves. In this corporation’s case, there is evidence that shows that the inventory written-down over the past three years has been a reduction by 10%. Therefore, a likely negative consequence to the stakeholders and financial statements would be the imposition of a 75% Civil Fraud Penalty of the owed tax that is being attributed to the fraud. Additionally, the same is likely to be subjected to an interest. In the majority of cases, this is the most common results of an IRS audit that generates penalties and additional tax (Dickie, 2006). Second, the stakeholders and financial statements of the corporation may be referred for criminal prosecutions. In the occurrence of this, the corporation may be subjected to Criminal Tax fraud, whose implications would be jail costs and long prosecution times. Third, the inventory write-down may severely affect the corporation to an extent that it may result in the prosecution and jailing of either the CEO or the CFO or both of them together. On the other hand, conduct of subsequent audits will affect the corporation in the sense that it will continuously drill down and drain the accounts financially due to the consistent costs incurred. Subsequently, the audits will deeply peruse into the accounts and further reveal more discrepancies, which may persist to impair the operations of the corporation. For instance, such enormous financial discrepancies if revealed may socially affect the corporation’s image and paint it as a fraudulent organization in the corporate sector and in the public view. Should such an occurrence take place, the stakeholders may likely lose faith and trust in the current management and even opt out of the corporation or replace the previous administration. In the communal view, the corporation’s operations may decline: consequently, affecting its productivity leading to a loss in the shareholder’s equity (Brigham & Ehrhardt, 2013). Question 3 Applicable federal tax laws, regulations, rulings and court cases relating to inventory write-downs There are certain federal tax laws and regulations that allows for the corporations to write-down on their inventories. In the event of inventory write-downs, especially those that have been damaged, lost, stolen, or even declared unsellable, there could be a cut on the tax bills. According to the Federal Tax laws, a corporation may claim the inventory write-downs or write-offs. On the other hand, this has to necessitate the acknowledgment and determination by the corporation of its inventory value through the use of one of the valuation methods of IRS that have been approved. For instance, as recognized by the Cost valuation method, all the direct and indirect costs of inventory should be summed up, including even the allied costs and transportation costs in determining the inventory value. Alternatively, the inventory value may be obtained by comparing the market value and the lower of the cost. All these are regulations that govern inventory write-downs. Additionally, there could be claims on the inventory write-downs by it being subjected to situations of theft, flood, fire, or non-sellable conditions. The law on this states that, the claim can be as part of the cost of the goods or as a separate adjustment. In relation court cases on inventory write-downs, the universal cases would be such as those of WEST COVINA MOTORS, INC. TC MEMO 2008-237. In this case, the determination by IRS was that the taxpayer had failed legally in substantiating its inventory write-downs. By the taxpayer using a different account, the Inventory Reserve Account, it was established to have debased the IRC 471 by relying a great deal on the reserve. In fact, the corporation was using the market value or lower cost methods to value its inventory (Moyer, McGuigan & Kretlow, 2009). While legally it is required that a taxpayer writes-down the inventory in the same year as the decline whether the goods are sold or not, West Covina Motors, Inc. was found to have dishonored this. When the subject was brought forth in the tax courts of law, it was ruled that no substantiation could be made on whether the reduction actually occurred; hence, it could not be allowed to be part of the computation of taxes for the corporation. A second court case would be the Best Auto Sales, Inc. vs. Commissioner Case. In this case, the determination by the tax court was that the testimony of the corporation’s president at the end of the year was comprised of estimates on the automobiles’ value but, with no basis for the claimed inventory write-downs. Hence, the inventory write-down claims could not be allowed by the court (Fox, 2013). Question 4 The current Generally Accepted Accounting Principles (GAAP) regarding stock option accounting The accounting for stock options for employees is defined by the USA GAAP under the FAS 123R. In the definition, the same is recognized as stock options expenses that are given to the employees in a period of vesting usually between the date of grant and the exercise date. There are two main options through which the corporation’s expenses can be recognized. These are: by use of a fair measurement value and/or by the use of an intrinsic value measurement. If a company chooses the latter method, then the expense at the grant date or any further date of measurement becomes the quoted excess of the market value price over the exercise price that the employee will have to pay. If the former option is preferred then, the acknowledgment will be in the course of measuring of the stock options’ expense at its grant date and based on award value, recognized over the period of service. According to Opinion No. 25 of the ASB notes that all entities are allowed the freedom to use the intrinsic value-based method for purposes of accounting, in contrast to the principles as set by IFRS 2. If firms approve of this method, they will be required to submit pro forma disclosures for all their net incomes and earnings per share (EPS). This basically would be as if the fair value-based method is applied. In the case under study in this paper, the pinnacle executives of the company have exercised the year’s options, yet the expenses for the same have not been provided for in the financial statements. Such a conduct is quite contrary to the principles of GAAP. As a therapy, it is supposed to be expected of the company to provide the compensation costs it bears when providing the options. On the other hand, if the company agrees to apply the intrinsic value-based method, it will be required by GAAP principles to expense, in the current year, all the excess of the market price over the exercise price. Consequently, it should be required to disclose in its financial statements, the impact of the net income and the earnings per share (EPS) on the occasion that the fair value technique is applied. In fact, even the stock option numbers issued should be disclosed (Fox, 2013). References Brigham, E. F., & Ehrhardt, M. C. (2013). Financial management: Theory and practice. Mason, Ohio: South-Western. Dickie, R. B. (2006). Financial statement analysis and business valuation for the practical lawyer. Chicago, IL: ABA Section of Business Law, American Bar Association. Fox, R. (2013). Tax Strategies for the Small Business Owner: Reduce Your Taxes and Fatten Your Profits. Las Vegas: Apress. Lymer, A., & Oats, L. (2012). Taxation: Policy and practice. Birmingham: Fiscal Publications. Moyer, R. C., McGuigan, J. R., & Kretlow, W. J. (2009). Contemporary financial management. Mason, OH: South-Western/Cengage Learning. Wahlen, J. M., Bradshaw, M., Baginski, S. P., & Stickney, C. P. (2010). Financial reporting, financial statement analysis, and valuation. Mason, Ohio: South-Western. Read More