Why Bonuses Will Be Affected Negatively and Effect on Pretax Earnings
Bonuses will be affected negatively because Danville Bottlers overstated the ending inventory and thus overstated gross profits that would result in lessened net income that directly affects the bonuses negatively. The ending inventory was overstated meaning that the cost of goods could have been understated creating a dilemma for both the bonuses and the pretax earnings. The tax liability on the company is calculated based on the gross profit of the company. For the given scenario, overstating its inventory resulted in a reduction of the cost of goods and an overall increase in the tax liability of Danville Bottlers. The overstating of the inventory may also affect the pretax earnings negatively since Danville Bottlers may overpay taxes.
Reporting on Financial Statements After Discovering in the Audit of the Following Year
In case the error in the inventory is not found and corrected within the current year and is later recognized in the following year, it would be necessary to have it corrected in the audit that follows in the following year. However, it is important that audit reports are accurate so that they can enable banks, investors, and other stakeholders to make good financial decisions (Gaynor et al., 2016). The given scenario would have to be corrected by creating an adjustment journal entry in order to debit and credit the earnings that would be affected. The earnings that would be affected could include an overstatement in the cost of goods sold. The audit error can also be corrected in the audit of the current year but this would create a ‘wash’ state. The ‘wash’ state occurs when the overstatement is shifted to the problem of the cost of goods sold and then overstating the cost of goods sold within the auditing period of the current year. Audit reports usually have a column where the financial data of the previous year has been indicated. This makes it easier for the auditors to be able to demonstrate the values that have been corrected (Kwok, 2017).
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Ethical Dilemma Faced by John Howard
Undertaking different activities in the modern workplace environment is challenging and different people are expected to face several ethical dilemmas throughout their work. Any company or organization can choose to deliberately take part in unethical practices and this could have dire consequences. John Howard faces the ethical dilemma of either pointing out the current inventory error or being silent with the inventory error until it is discovered in the following year. The first decision could result in suffering as there could be a reduction in everyone’s profit-sharing bonus. However, such a decision may result in dire consequences for the company and John’s credibility if discovered later that he did the action deliberately so that he could pocket additional profits (Barker & Frederick, 2016).
The second decision that involves pointing out the inventory error and having profits reduced is the ethical and moral decision. 2 Corinthians 8:21 advocates that we should be ready to take pains to do what is right before the eyes of the lord and the eyes of man. Even though the decision may result in suffering, it is the right decision in the eyes of the lord and of man. The decision will enable investors to gain a clear view of the company’s progress and growth. This should add credibility to John Howard and may promise goodness in the far future. Doing what is right should be the basis of John’s decision and for the given scenario the right decision involves pointing out the errors in the current year.
References
Barker, J., & Frederick, C. (2016). Billions Lost Yearly To Earned Income Tax Credit: Errors Or Fraud?. Journal of Business & Economics Research (Online) , 14 (4), 145.
Gaynor, L. M., Kelton, A. S., Mercer, M., & Yohn, T. L. (2016). Understanding the relation between financial reporting quality and audit quality. Auditing: A Journal of Practice & Theory , 35 (4), 1-22.
Kwok, B. K. (2017). Accounting irregularities in financial statements: A definitive guide for litigators, auditors and fraud investigators . Routledge.
