Question

The net realizable value of Lake Corporation’s inventory has declined below its cost. Allyn Conan, the controller, wants to use the loss method to write down inventory because it more clearly discloses the decline in the net realizable value and does not distort the cost of goods sold. His supervisor, financial vice president Bill Ortiz, prefers the costof-goods-sold method to write down inventory because it does not call attention to the decline in net realizable value. Instructions Answer the following questions. (a) What, if any, is the ethical issue involved? (b) Is any stakeholder harmed if Bill Ortiz’s preference is used? (c) What should Allyn Conan do?

Short answer

1. The ethical issue includes reporting the decline by using the cost of goods sold method, in which loss is included in the cost of goods sold which is against the accounting principle.
2. Yes, it may harm stakeholders.
3. Allyn Conan should report the inventories using the loss method.

Step-by-step solution

Ethical issue

a. Per the suggestion of Bill Ortiz, the decline in the value of inventory is to be recorded following the cost of goods sold method. Under the method, the decline in the inventory value is included in the cost of goods sold. In this method, the loss is added to the cost of goods sold, which is incorrect as it should be reported separately in the income statement.

Effect on stakeholders

b. Under the cost of goods sold method, the decline is included in COGS, so the stakeholders have no information about the decline in inventory value, which is incorrect. Stakeholders should be aware of a decline in the value of inventory. Hence it should be reported separately in the income statement.

Desired action of Allyn Conan

c. Allyn Conan should discuss the advantages of reporting the loss by loss method with the vice president. He should report the decline in inventory by using the loss method as it improves stakeholder satisfaction.