Inventories, Income Determination, and Ethics

Response to Classmate 1

I agree with you in some of your arguments; however, in my opinion, the goods should not be considered unearned revenue because the client has not paid for them yet. The client just placed the order without any further commitment. An entry for unearned revenue can only be made when the goods are paid for before the shipment; thereafter, an adjusting entry is made after delivering the goods to customers. Indeed, Lutz’s actions were not ethical; her instructing the controller to recognize the sale in the fiscal year 2014 and not to record the cost of sales until next January 1, 2015, fails to comply with the principle of recognition. The cost of sales is accumulated when the sales are made. The transaction cannot be recorded in two separate accounting periods. If the controller follows Lutz’s instructions to record the sales, the profit for the year will be overstated, and the users of the financial information may be deceived; this results in wrong decision-making. On the other hand, the profits for the financial year 2015 will be understated because the only cost of sales will be charged to the income statement, while sales will not be recognized again in the year. Compromising the accounting principle will do the business more harm than benefit.

Reference

Hoyle, J. B., Schaefer, T., & Doupnik, T. (2015). Advanced Accounting. Mcgraw Hill.

Christensen, T., Cottrell, D., & Baker, R. (2013). Advanced Financial Accounting. Mcgraw-Hill.

Response to Classmate 2

Great perspective! It is true that Lutz’s actions overstated the business profitability in 2015 and similarly inflated the firm’s balance sheet as of December 30, 2014. This is so because failing to reduce the inventory account by the cost of sales results in the overstated value of the ending inventory and the assets. Lady’s profitability will decrease in 2015, and its assets in 2015 will also be affected by recognizing the cost of sales on January 1, 2015. The cost of sales will be charged to the income statement in 2015, and the inventory account will be reduced with the amount. This means that both the company’s profitability and financial position will be understated. It is unclear if the purchase order was fulfilled later, so recognizing the sales in 2014 to meet the financial goal is unethical. Inventory is only recorded correctly at the time when sales are recognized. If sales were recognized in 2014, the cost of sales should also be recorded in the same period. It is not ethical to recognize sales in one period and cost of sales in another period. Lutz should wait until the business is certain that the purchase order can be fulfilled.

References

Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2019). Financial Accounting Theory and Analysis: Text and Cases. John Wiley & Sons.

Weil, R. L., Schipper, K., & Francis, J. (2013). Financial Accounting: An Introduction To Concepts, Methods and Uses. Cengage Learning.

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Inventories, Income Determination, and Ethics

Hello, I need help responding to two fellow students responses to the discussion post about “Ethical Dilemma: Inventories, Income Determination, and Ethics”. Thank you.

Inventories, Income Determination, and Ethics

Classmate 1 Post

Session 3 Discussion

“Ethical Dilemma: Inventories, Income Determination, and Ethics.”

Margaret Lutz, president of Lady, Inc., receives a large order that would allow her to meet the annual financial goal; however, the order came in on December 30, 2014. She directs the controller to record the sale which accounts for 13 percent of Lady’s annual sale. She also directs the control department to not separate the goods for shipment until after January 1, 2015. The auditors that arrive to take the year-end physical inventory. What this affects is the cost of goods sold as well as the recognition of revenue. The goods have not been separated for shipment; however, the sale was directed to be recorded. Her profitability for 2014 would be at the financial goal for the year. It would be considered unearned revenue, but it was recorded within the company’s 2014 transactions. It should be an adjusted entry for the following year along with the cost of goods sold and overall physical inventory for it would be shipped in 2015. The ethics are questionable for it goes against the revenue recognition principle. The sale along with inventory should be recorded in the following fiscal year. I understand the emotional weight that comes along with wanting to meet the fiscal projections, but compromising the moral standard will lead to greater gray areas and dismissing the accounting process that keeps the system going. In Scripture it states, “So whoever knows the right thing to do and fails to do it, for him it is sin” (James 4:17, ESV). It is easy to judge without context and circumstance, but we must strive to not compromise ourselves for the sake of profitability. Let me know if you think I am wrong or any differing opinion on this!

Classmate 2 Post

Ethical Reporting

“Ethical Dilemma: Inventories, Income Determination, and Ethics.”

Lutz actions affected Lady’s profitability in 2014 positively by recording the sale and also inflated the balance sheet by including the sold inventory in their counts. This in turn decreased profitability for 2015.

The actions were not ethical. In what ways is somewhat dependent on the terms of the purchase, for example, was this FOB shipping or FOB destination, was this a purchase order to be fulfilled at a later date? If this was to be an immediate purchase, then the recording of the sale in December was appropriate; however, holding onto the inventory and not counting it as sold was unethical because it over inflates the balance sheet account for inventory and overstates the company’s financial position.

If the order was for a date after December, then the actions of Lutz were unethical because they overstated 2014’s income. In this scenario, I believe that the inventory would have been counted correctly because the sale isn’t final.