Inventories, Income Determination, and Ethics
Response to Classmate 1
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I agree with you in some of your arguments; however, I believe 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; after that, 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. 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 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 unethical to recognize sales in one period and the cost of sales in another. Lutz should wait until the business is specific to fulfill the purchase orders:
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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). Fin,ancial Accounting: An Introduction To Concepts, Methods, and Uses. Cengage Learning.
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Question 
Inventories, Income Determination, and Ethics
Hello, I need help responding to two fellow students’ responses to the “Ethical Dilemma: Inventories, Income Determination, and Ethics discussion post.” 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., received 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’not total sales. She also directs the control department not to separate the shipment of the goods until after January 1, 2015. The auditors 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 even,ue recognition principle. The sale and inventory should be recorded in the following fiscal year. I understand the emotional weight of wanting to meet the fiscal projections. However, compromising the moral standard will lead to more significant gray areas and dismissing the accounting process that keeps the system going. Scripture states, “So whoever knows the right thing to do and fails to do it, for him it is sin” (James 4:17, ESV). Judging out of context and circumstance is easy, but we must strive not to compromise ourselves for profitability. Let me know if you think I am wrong or if you have a different opinion!
Classmate 2 Post
Ethical Reporting
“Ethical Dilemma: Inventories, Income Determination, and Ethics.”
Lutz’s actions positively affected Lady’s profitability in 2014 by recording the sale and inflating 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 it 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 December sale recording was appropriate; however, holding onto the inventory and not counting it as sold was unethical because it 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. I believe the inventory would have been counted correctly in this scenario because the sale isn’t final.