Question 1. Repercussions of Failing to Include Inventory Write-downs and Recommendations to the CFO
The general purpose of financial statements is to provide information about an entity's financial performance, financial position, and cash flows. One of the requirements when reporting in the financial statement is to include inventory write-downs to document charges of a portion of the inventory asset to the expense at the current period. The write-down can occur when the value of goods has declined or when they are lost or stolen. Failure to include inventory write-downs in the financial statements will lead to the organization fraudulently presents its assets, leading to ethical issues with the financial statement's presentation. It can also lead to financial repercussions where an organization overestimates its earnings. Such overestimation of a company’s financial statements could be an indicator of fraud, with the organization showing itself to be more valuable than its actual value (Cianci et al., 2017). When discovered, organization investors are likely to lose confident in the management, and there are likely to be financial penalties for fraud.
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The recommendation to the organization is that it should establish a proper internal control procedure that should prevent fraudulent reporting. One of the first internal control approaches will involve the organization’s leadership not showing any tolerance to fraudulent activities. The leadership should explicitly indicate what it expects of its employees and then indicate that there could be severe repercussions on any employee in case of fraudulent activities. Another internal control measure that can be applied involves using internal whistleblower programs to ensure that other employees can report any issue to the organization’s financial dealings. The staff involved in preparing financial statements should go through constant training and education regarding the correct financial reporting practices. Other recommendations for the organization will include creating an organizational culture that promotes honesty and critical auditing and financial statements before the final report.
The CEO and CFO should ensure compliance with the company’s internal control procedures. Their first responsibility is to ensure that the preparation of financial statements aligns with ethical practices. Before signing any financial statement, the CFO and CEO should critically ensure that the information presented is truthful. Additionally, the CEO and CFO should ensure that the organizational employees follow internal control systems' recommendations.
Question 2. Adverse Effects on Stakeholders and Financial Statements of an IRS Audit
An IRS audit can generate additional tax, penalties, and subsequent audits that can impact the company’s financial statement by reducing its net income. The result will be a reduction in the company’s profits and a reduction in the dividends paid to shareholders at the end of the financial year. In case the imposed penalties are significantly high, it would negatively impact the organization's long-term financial structure and could lead to bankruptcy. The evidence of fraud will also negatively impact the company’s reputations, and investors could leave the company.
From the IRS examination, the inventory was written down by ten percent over three years. In such a case, the IRS Civil Fraud Penalty will be imposed, and the organization will lose ten percent of its income every year (Sardar, 2019). The IRS could proceed with criminal prosecution and the individuals found guilty of committing the tax fraud could serve time in jail or face huge penalties. The other stakeholders that the criminal litigation could impact are the company’s leadership, such as the CFO and CEO, who could be prosecuted. Other stakeholders that depend on the organization’s services, such as bank institutions when lending money, suppliers, and customers, will be affected when it reduces its operations. The analysis shows that the evidence of fraud in the company’s financial statements will negatively impact a company's financial structure, and it could impact almost all stakeholders depending on the company’s services.
Question 3. Applicable federal tax laws, regulations, rulings, and court cases with inventory-write downs.
The requirement for inventory write-downs has been outlined by the Financial Accounting Standards Board (FASB) in the issued statement no. 151, Inventory costs, an amendment to the Accounting Research Bulletin (ARB), chapter 43, no. 43. The statement observes that an organization should write down its inventory by clarifying any abnormal amounts of an idle facility, freight, and wasted materials (“Accounting FASB issued Statement no. 151”, 2021). The federal laws require that an organization determine its inventory value by using valuation methods approved by the IRS.
One example of a court case that provided clear guidelines with financial reporting was the “West Covina Motors, Inc. V. Commission of Internal Revenue.” The ruling from the case addressed several issues dealing with West Covina Motors' approach in its inventory write-downs. One of the main outcomes of the case was that the organization failed to substantiate its inventory write down, and it violated regulations under section 471 by making use of reserve amounts (“West Covina Motors v. Commissioner”, 2009). The ruling of the case was that the company was responsible for presenting the inventory write-down honestly and truthfully. However, West Covina Motors did not sufficiently verify its inventory write-downs. The given case showed the need for organizations to follow regulatory requirements during an inventory write-down. An understatement of the inventories could result in multiple fines and penalties on an organization.
Question 4. Generally accepted accounting principles (GAAP regarding stock option accounting.
The United States uses the GAAP as an accounting standard. The stock option accounting is outlined in FAS 123R of the GAAP, which observes that share-based payment, revised editions, and private and public payments in a business should acknowledge stock-based compensations throughout the write-downs. The requirement is that stock options' expenses should be given to the employees in the specific periods between the exercise date and grant date. The expenses should be recognized by making use of intrinsic value measurements or fair value measurements. The intrinsic value measurement observes that the expense at grant or further measurement date is given as the excess of the quoted market price that the employee should pay. The fair value measurement involves calculating the expense at the grant date by following the award's value throughout the service period. Section 25 of the ASB observes that businesses are required to use the intrinsic value-based approach. If the procedure is followed, a pro forma disclosure of net income earnings per share should be used.
The treatment of a company’s share-based compensation plan through GAAP reporting should follow the FAS 123R guidelines. The observation is that a firm should provide compensation costs if it provides stock options. The firm should also disclose the net income's effect and the earnings per share when the fair value approach is applied.
There are financial benefits and risks of the share-based compensation compared to that of the share-based stock-appreciation rights plan (SARS). The share-based system involves using share-based awards to employees and settling them through cash. The employee will be required to purchase essential shares as equity. However, they would have to hold them for some time and be exposed to the compensation’s risks and awards. The SARS is a right enabling workers to acquire bonuses equal to a company’s stock appreciation. It is similar to the share-based compensation, but the SARS will be highly beneficial to workers if there is an increase in the stock price (Nichols et al., 2017). However, a firm that follows the stock appreciation rights should record a compensation charge on its income statement when the award to employees increases. The value should be adjusted every year based on the required award.
The recommendation to the CFO is that the company should follow the SARS approach as it can be beneficial to motivate workers and attract talented individuals. The approach is also beneficial since workers may not be required to purchase anything from the company.
Question 5. Reporting requirements for lease reporting under GAAP and International Financial Reporting Standards (IFRS)
Leasing is a critical activity for company’s as it enables the usage of a unit within a specific period and generates revenues. The GAAP and IFRS standards identify that there should be specific reporting requirements for leases. The balance sheet should document the lease as an underlying asset in the form of a capital lease. The lease requirements and any transactions under the lease should also be documented as a sale. The difference between the GAAP and IFRS in the reporting of leases involves the lessee's discount rates and the recognition of profits and losses under the agreement.
The proposal for future lease transactions will involve the CFO establishing an elaborative lease policy for both a capital lease and an operating lease. The firm should follow a systematic approach when showing transactions of the different types of a lease on the balance sheet. Capital leases are treated as assets, where the lessor finances the leased asset, and all the rights of ownership are transferred to the lessee. The recording of the asset is under the lessee’s property in the general ledger and is a fixed asset. The transaction should thus be included on the company’s balance sheet. On the other hand, an operating lease involves a contract that allows for an asset's use but does not transfer the ownership of the asset (Giner & Pardo, 2018). The lease's advantage is that the lessee will not have the burden of sharing the entire risk. The operating lease transaction should not be treated as an asset in the balance sheet.
Question 6. Argument for Single Set of International Accounting Standards
The current approach and standards to accounting practices involve applying different rules to different countries. The challenge comes about when undertaking cross-border transactions and establishing companies in different countries. Establishing a single set of international accounting standards will make financial reporting easy for multinational companies leasing assets from different countries. The use of a single set of international accounting standards will also help improve investment decisions for companies that have leased assets. Investors from different countries need high quality and a single set of data to easily analyze business decisions.
The risk in using a single set of international standards for organizations is that it may take time and effort for organizations to shift to the new standards. The shift can result in multiple changes from the current GAAP standards leading to challenges in successfully implementing the new standards for lease agreements. The success of the approach requires an effective international quality regulation and an organization or commission that oversees the implementation of the new standards.
Question 7. Implications of SAS 99
The SAS 99 is a statement for the “Consideration of Fraud in a Financial Statement Audit.” It ensures that the auditor can handle the auditing so that any fraudulent activities of the company can be discovered. A proper reporting procedure should then be followed after identifying any underlying frauds (Choudhary et al., 2018). It was established for the company that the company had taken part in an inventory write-down where the income tax was excluded from the financial statement. The IRS labeled such an omission as a fraud. The SAS 99 could have been applied in the given case to ensure that the auditors had undertaken an independent examination of the financial statement and reveal the possibilities of fraudulent reporting.
The implication of the SAS 99 is that it will reveal that the organization did not comply with the correct auditing procedures. The business may require another auditing to comply with the regulations. The audit would aim to show whether the financial statements' reporting was caused by an error or was fraudulent reporting. The new financial statement should provide additional guidelines to the management about preventing similar errors in its reporting in the future.
Question 8. Potential for Misstatement in Financial Statements
There is a potential for misstatement in the previous financial statements. It could be caused by accounting errors, non-compliance with account principles, and fraud. Accounting errors could have occurred because one of the employees did not accurately report the financial statements. The recommendation to the CFO is to restate the financial statements. The corporation had its IPO in the past five years, and there is a need to restate its financial statements. Restating them will eliminate any errors associated with the previous reporting. The financial statement can be altered for the previous year and then released to the public.
There could be several issues that could arise in case the organization declines to restate its financial statements. The first issue is that it will show that the organization is unwilling to correct its errors and may continue with the fraudulent report. To prevent a future misrepresentation of the company’s financial statements, the IRS could pursue legal actions against the company, and the result would be a huge fine and penalty. The next problem will occur when the company experiences a huge fine from the poor reporting. The company could experience a significant loss, and if it has a large debt, it could fall into bankruptcy. The third problem with the reporting could occur when dealing with the company’s investors. The IRS already publicly claimed the inventory write-down. Many investors would be observing the company to ensure that it restates its financial statements correctly for a better analysis of the company. Investors are likely to mistrust and leave the company if the financial statement is not restated.
Question 9. Economic Effect of Restatement of Financial Statements
Restating the financial statement will impact different stakeholders, including the investors, employees, customers, and creditors. Investors are likely to lose confidence in the company, especially when the accounting errors become established directly from the company’s management. The possibility of a lawsuit and bankruptcy will impact the company’s financial structure negatively, and creditors are likely to demand faster payment of their debts. They can also ask for securities for their debts and sue the company in case of late repayment of debts. The company will have a difficult chance of getting debt from investors. Employees and customers will also react negatively to the restatement. The company can lose customers, especially when it emerges that it was involved in fraudulent behavior. Some customers can choose to revisit the company’s contracts. The restatement will impact employees as it will affect morale and motivation. Some employees can be dissatisfied with the company’s fraudulent activities and may choose to leave. After restating the financial statement, the company should address the concerns of all the stakeholders. It can hold a press briefing where it addresses all the questions.
References
Accounting FASB issued statement no. 151. (2021). Journal of Accountancy. https://www.journalofaccountancy.com/issues/2005/feb/accounting.html
Choudhary, P., Merkley, K., & Schipper, K. (2018). The last chance to improve financial reporting reliability: Evidence from recorded and waived audit adjustments. SSRN Electronic Journal , 21(06). https://community.bus.emory.edu/FacultySeminars/Shared%20Documents/Choudhary,%20Preeti%20-%20workshop%20paper.pdf
Cianci, A. M., Houston, R. W., Montague, N. R., & Vogel, R. (2017). Audit partner identification: Unintended consequences on audit judgment. Auditing: A Journal of Practice & Theory , 36 (4), 135-149. https://doi.org/10.2308/ajpt-51629
Giner, B., & Pardo, F. (2018). The value relevance of operating lease liabilities: Economic effects of IFRS 16. Australian Accounting Review , 28 (4), 496-511. https://doi.org/10.1111/auar.12233
Nichols, N., Betancourt, L., & Scott, I. (2017). The FASB Simplifies the Accounting for Share‐Based Payments. Journal of Corporate Accounting & Finance , 28 (4), 8-19. https://doi.org/10.1002/jcaf.22275
Sardar, M. (2019). IRS Issues New Guidance for Offshore Voluntary Disclosures. Tax Stringer, April . https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3575871
West Covina Motors v. Commissioner. (2009). Casetext.com. https://casetext.com/case/west-covina-motors-v-commissioner
