Ethics Case 19-3

Ethics case 19-3 deals with issues related to a company changing its inventory method from LIFO to FIFO and any perceived ethical dilemmas that might be involved due to stock options being influenced by the company’s net income. Often times, companies will change their inventory method due to changing circumstances such as different economic conditions, changes within an industry, or even from a mandated change by the FASB (Spiceland, Sepe, & Nelson, 2013). The reason the company in this question gives for changing its inventory method is due to the fact that it more closely aligns with other companies in the same industry. While this seems like a justified reason for changing their inventory method, the discovery of an executive stock option

Jesswein (2010) says that switching from LIFO can cause income statements to report higher earnings. This confirms the auditor’s suspicions in his calculations of net income if the company changes inventory methods from LIFO to FIFO. In other research by Healy (1985), it is sometimes the case that “executives rewarded by bonus schemes select income-increasing accounting procedures to maximize their bonus compensation” (p. 85).
Requirement 2: What would be the likely impact of following the controller’s suggestions? If the company follows through with changing its accounting procedures for inventory, then it seems very likely that the company will exceed its net income goal of $44 million. This will then increase the amount of shares available to executives through the stock option plan. As an auditor though, if it were discovered that these shares were attained through unethical means and the auditor had known about it but had not said anything, then there could be potential trouble for the auditor and their reputation.
Requirement 3: Who would benefit? Who would be