Question

Rick Pines and Joe Lopez are the plant managers for High Mountain Lumber’s particle board division. High Mountain Lumber has adopted a just-in-time management philosophy. Each plant combines wood chips with chemical adhesives to produce particle board to order, and all product is sold as soon as it is completed. Laura Green is High Mountain Lumber’s regional controller. All of High Mountain Lumber’s plants and divisions send Green their production and cost information. While reviewing the numbers of the two particle board plants, she is surprised to find that both plants estimate their ending Work-in-Process Inventories at 75% complete, which is higher than usual. Green calls Lopez, whom she has known for some time. He admits that to ensure their division would meet its profit goal and that both he and Pines would make their bonus (which is based on division profit), they agreed to inflate the percentage completion. Lopez explains, “Determining the percent complete always requires judgment.

Whatever the percent complete, we’ll finish the Work-in-Process Inventory first thing next year.”

Requirements

1. How would inflating the percentage completion of ending Work-in-Process Inventory help Pines and Lopez get their bonus?
2. The particle board division is the largest of High Mountain Lumber’s divisions. If Green does not correct the percentage completion of this year’s ending Work-in-Process Inventory, how will the misstatement affect High Mountain Lumber’s financial statements?
3. Evaluate Lopez’s justification, including the effect, if any, on next year’s financial statements.
4. Address the following: What is the ethical issue? What are the options? What are the potential consequences? What should Green do?

Short answer

1. The cost per unit of the board is reduced by exaggerating the proportion of work completed in the process.
2. Due to the obvious misstatement, the company's Gross Profit and Net Income will increase.
3. Lopez’s justification is true.
4. Green should report the information correctly when completing the company financials.

Step-by-step solution

Meaning of Work-in-Process

Work in progress refers to items that have been partially completed but are still in the manufacturing process. These objects are in-between locales or separate workstations and are primarily undergoing a particular procedure in the manufacturing cycle.

(1) How Pines and Lopez get their bonus

Fewer expenses would allocate to the Finished Goods Inventory if the percentage of completion for the work in process were increased, decreasing the cost per unit of the board. It would cut the Cost of Goods Sold while increasing the Gross Profit. Pines and Lopez will receive a more significant bonus if Gross Profit determines the award.

(2) Misstatement that affects High Mountain Lumber’s financial statements

The corporation will display higher Gross Profit and higher net income on the Income Statement due to the falsification of the percentage of completion for the work in progress. On the balance sheet, it would also overestimate the Work-In-Process Inventory.

(3) Evaluating Lopez’s justification

Lopez's reasoning that they would finish the work in progress the following year is correct; nonetheless, expenditures would be transferred to the following year's income statement, resulting in a reduced net income in the following year.

(4) Explaining the ethical issue, options, potential consequences, and what is done by Green

The moral issue here is the status of lying in arrange to get a reward. What different moral judgments would Lopez and Pines be willing to form to create the financials show up way better if they do not have an issue with the misstatement? Another factor to look at in this case is the amount's materiality. Green may not alter if the sum is immaterial to the company's financials. Green ought to record the information appropriately while completing the firm financials if it is pertinent. It would give the administration and outside clients more prominent information on which to form choices.