Financial Statements, Inventory Write-Downs, and the Federal Tax Laws

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The main aim of the financial statements is to provide general performance information of an organization or a company. Various stakeholders such as the management, employees, investors, and creditors use the financial statements information to make decisions. When preparing the financial statements, the organization uses International Accounting Standards (IAS). There are no separate disclosures of the write-downs that are expected to be in the income statement according to the IAS; however, write-down information should be availed to facilitate a sufficient understanding of the income statements. For instance, an investor may overestimate the earnings due to a lack of inventory write-downs that may bring about ethical issues (Schroeder et al., 2019). In addition, inventory write-down has many impacts on both the balance sheet and the income statement since they are normally treated as an expense that reduces the tax liability and net income. Retained earnings are reduced by reducing net income, which in turn reduces the shareholder's equity in the balance sheet. The balance sheet inventory asset value reduces to its Net Realizable Value (NRV). Reduction of the net income may bring about ethical issues to the shareholders due to a decrease in Earning Per Share (EPS) if the inventory write-downs are not disclosed.
As an accounting firm partner, I am mandated to inform the CFO of the negative Internal Revenue service assessment consequences. An observation by the IRS on including inventory write-downs to lower the tax payable, whereas there are no disclosures in the financial statements, is not allowable. In this case, underpayment of the taxes attracts a civil tax fraud penalty which is computed based on the understatement. Civil tax fraud can attract up to 75% of the penalty of underpayments (Levi, 2010). Once the interest is factored in, the accrued interest on the penalty can even exceed the tax amount that would be payable. Essential control procedures such as segregation of the duties, which involves different employees were performing other functions to reduce any possibility of fraud. Implementation of the whistleblower program, which encourages the employees to report any fraudulent activities observed without fear of action against the employees, especially on the established accounting practices and procedures, are part of the controls that will help in curbing fraudulent activities in the organizations. To ensure compliance, the CEO and the CFO should ensure that the preventive measures such as revenue matching with cash flows and instilling the right culture are all implemented.
According to the examination by the IRS, it's apparent that over the last three years, the company has been writing down some of the inventories by a margin of 10% due to loss or damage. The case can be referred to the criminal prosecution by IRS or instill a penalty to the company. The CFO and the CEO can also be prosecuted since they are liable for the omissions. If the accounts are further audited and the auditors discover more discrepancies, the investors as part of the stakeholders would lose confidence in the company, which can negatively affect the company in terms of finances. Additional taxes or penalties will have adverse effects on the stakeholders. If the stakeholders deem the company's financial statements unreliable, they will lose trust in the management. Further, the earnings per share will reduce due to the penalties imposed on the company (Kent and Stewart, 2008).
Applicable federal tax laws
GAAP accounting principles have been adopted by the United State Securities and Exchange Commission. The same principles are applied in companies to ensure the financial statements prepared by various companies are similar, making it easy to compare them. In addition, there are court precedence and other regulations that provide frameworks and methods that companies must always follow when preparing their financial reporting. The inventory write-downs regulations are generally provided in the Internal Revenue Code. The two primary methods used in the inventory valuation, according to IRC section 471, are cost and lower price. Changes in accounting methods, maintenance of records, and inventory market value are determined and governed by other regulations ((Lucchese and Di Carlo,2020). The inventory write-downs governed by the federal tax laws are essential in writing off the stolen inventory or damaged goods that can reduce the tax bill.
The company must determine the value of the inventory through a method that the IRS has determined before claiming an inventory write-off. All the direct and indirect costs of the inventory, such as transportation and any other related fees, should be summed up when using any of the cost methods provided (Beechy et al., 2011). Some of the inventory write-down cases include Artnell Company in 1968 and Cincinnati, New Orleans & Texas Pacific Railroad in 1970. In determining the income, the court held that the GAAP was entitled to some probative value. In a landmark ruling case between the commissioner and the Thor Power Tool Company in 1979. The company was reported to have lowered its cost through inventory value, and the company inventory was determined to be overvalued upon the management change. The court ruled that the Thor power company had violated the treasury regulations that demanded inventory actual offer at a reduced price to determine the inventory lower market value.
The options were normally reported on the notes section of the financial statements according to Generally Accepted Accounting Principles (GAAPS) until 2006. The notes had no impact on the financial statements. GAAP code FAS 123 modification in 2006 required companies to show options in the income statement as an expense. It indicates that the option costs are supposed to show employees' compensation and other fees and salaries. In addition, the provision requires the stock options offered to all the employees to be recognized investing period. The recognition can be done either through intrinsic value or fair value measurements. If the intrinsic value method is applied, the current price excesses over the exercise price must be expensed in the current year.
Cash flows
For appreciation rights of the stock, an increase in the prices of the stock is normally paid in cash to the employees. Cash payments affect the company negatively in the term, so the cash flows. In contrast to the stock option plan, the company issues the stock only posing no threat to the cash flows (Carruth,2003)
Ownership
Earnings Per Share (EPS) can significantly increase when stock options are represented in a higher percentage. This can pose a threat by diluting ownership; in contrast, the stock appreciation rights have no majority ownership interest making it suitable for large and complex businesses.
The CFO can opt for a stock appreciation rights plan since the company is undertaking the Initi...