Evaluate any damaging financial and ethical repercussions of failure to include the inventory write-downs in the financial statements. Prepare a recommendation to the CFO, evaluating the negative impact of a civil fraud penalty on the corporation as a result of the IRS audit. In the recommendation, include essential internal control procedures to prevent fraudulent financial reporting from occurring, as well as the major obligation of the CEO and CFO to ensure compliance.
Inventory write-downs are recorded by reducing the amount reported as inventory. Inventory write-downs include the operating expenses that the management team or the company has incurred. Failing to include the inventory write-downs in the financial statements is a violation and this could cause investors to overestimate earnings raising ethical concerns. Omitting inventory write-downs could also raise other financial and ethical issues like excessive compensation of corporate managers, concealment of fraud penalties and loss of confidence in the management by the shareholders. Financial statement fraud leads to a decrease in the market value of company stock of up to a thousand times the amount of the fraud (Jack, Levin, Craig, & Primis, 2002).
The IRS upon discovering the concealment of the transaction has labelled the treatment of the write-down as fraud. Companies have been using inventory write-downs to reduce their taxable income or even to hide the failures of managers. A civil fraud penalty by the IRS is equal to 75% of any federal tax that is not paid as a result of the financial fraud. Any part of the tax underpayment that is not related to the fraud may attract an accuracy penalty instead. The civil fraud penalty would also cause the value of the assets that the company has acquired to depreciate and make the company less attractive to investors. In order to prevent fraudulent financial reporting from occurring, companies need to establish a positive internal control environment. Any illegal and inappropriate acts should be prevented from occurring. The internal control system should comprise of separation of duties, physical safeguards over assets, adequate supervision, proper documentation and authorization. CEOs and CFOs have the responsibility of ensuring adequate internal control structure and assessing the effectiveness of the internal control systems. Any shortcomings in the controls should always be reported. In addition, external auditors should ascertain that internal accounting controls are effective and operative (Trainer, 2011). Examine the negative results on stakeholders and the financial statements of an IRS audit which generates additional tax and penalties or subsequent audits. Assume that the subsequent audit and / or additional tax and penalties result from the taxpayer’s use of an inventory reserve account, applying a 10 percent reduction to inventory over three (3) years. An IRS audit that generates additional tax and penalties or subsequent audits can have various negative results on stakeholders and financial statements. Additional tax and penalties would decrease income and revenue for the company. In addition, the value of the company’s assets would reduce and this would in turn reduce the value of shares of the shareholders. If the earnings of the company are overstated as a result of the omitted write-down, the investors and shareholders are deceived and when the earnings are understated, then buyers loose (Turner, & Weirich, 2009). Some companies committing financial fraud are experiencing net losses in periods before the fraud. If this was the case with the company, additional tax and penalties or subsequent audits would eat into the little money that the company has left and this would lead to bankruptcy. Other parties that rely on the company’s financial information including banks and other financial institutions, as well as suppliers and customers will also be affected and the shareholders would be forced to pay some of these costs. Apart from additional taxes and penalties that eat into the income and cash reserves of a company, the true cost of financial fraud is incalculable as so many parties are affected (Trainer, 2011). Fraud is a costly business problem that leads to losses in income. In order to cover the effect on net income, revenues must increase by 10 times of the reduction. If the IRS audit generates additional tax and penalties or subsequent audits, the company will lose money. If a
Inventory write-downs are recorded by reducing the amount reported as inventory. Inventory write-downs include the operating expenses that the management team or the company has incurred. Failing to include the inventory write-downs in the financial statements is a violation and this could cause investors to overestimate earnings raising ethical concerns. Omitting inventory write-downs could also raise other financial and ethical issues like excessive compensation of corporate managers, concealment of fraud penalties and loss of confidence in the management by the shareholders. Financial statement fraud leads to a decrease in the market value of company stock of up to a thousand times the amount of the fraud (Jack, Levin, Craig, & Primis, 2002).
The IRS upon discovering the concealment of the transaction has labelled the treatment of the write-down as fraud. Companies have been using inventory write-downs to reduce their taxable income or even to hide the failures of managers. A civil fraud penalty by the IRS is equal to 75% of any federal tax that is not paid as a result of the financial fraud. Any part of the tax underpayment that is not related to the fraud may attract an accuracy penalty instead. The civil fraud penalty would also cause the value of the assets that the company has acquired to depreciate and make the company less attractive to investors. In order to prevent fraudulent financial reporting from occurring, companies need to establish a positive internal control environment. Any illegal and inappropriate acts should be prevented from occurring. The internal control system should comprise of separation of duties, physical safeguards over assets, adequate supervision, proper documentation and authorization. CEOs and CFOs have the responsibility of ensuring adequate internal control structure and assessing the effectiveness of the internal control systems. Any shortcomings in the controls should always be reported. In addition, external auditors should ascertain that internal accounting controls are effective and operative (Trainer, 2011). Examine the negative results on stakeholders and the financial statements of an IRS audit which generates additional tax and penalties or subsequent audits. Assume that the subsequent audit and / or additional tax and penalties result from the taxpayer’s use of an inventory reserve account, applying a 10 percent reduction to inventory over three (3) years. An IRS audit that generates additional tax and penalties or subsequent audits can have various negative results on stakeholders and financial statements. Additional tax and penalties would decrease income and revenue for the company. In addition, the value of the company’s assets would reduce and this would in turn reduce the value of shares of the shareholders. If the earnings of the company are overstated as a result of the omitted write-down, the investors and shareholders are deceived and when the earnings are understated, then buyers loose (Turner, & Weirich, 2009). Some companies committing financial fraud are experiencing net losses in periods before the fraud. If this was the case with the company, additional tax and penalties or subsequent audits would eat into the little money that the company has left and this would lead to bankruptcy. Other parties that rely on the company’s financial information including banks and other financial institutions, as well as suppliers and customers will also be affected and the shareholders would be forced to pay some of these costs. Apart from additional taxes and penalties that eat into the income and cash reserves of a company, the true cost of financial fraud is incalculable as so many parties are affected (Trainer, 2011). Fraud is a costly business problem that leads to losses in income. In order to cover the effect on net income, revenues must increase by 10 times of the reduction. If the IRS audit generates additional tax and penalties or subsequent audits, the company will lose money. If a