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Case background
Financial accounts are prepared to reflect a true and fair financial standard of an organization for the period that the accounts cover. In the case of Dhalshun Ltd, the company has not been performing well however due to pressure from investors and capital lenders, the company would like to report high profits to give an impression of a strong going on concern business. Andrew Jentai, the companies COO, has proposed a system that is aimed at reporting better financial reports. This paper discussed the decision of the COO from an accounting point of view.
Whether Andrews plan will enable the company to report a higher profit for the year
Andrew wanted the company to buy high volumes of stock since at the time they were low in cost and use the LIFO (last in first out) method of stock valuation. In LIFO, the value of a stock is equal to the value of goods that were stocked earlier. In this case, the cost of inventory is said to be going down. This means that those stocks that had been gotten earlier will be at a high price; closing stock will be higher.
- Gross profit = sales (purchases + opening stock closing stock)
then
From the above equation, if closing stock is high, then the gross profit reported will be high. Andrewss method will meet its main objective of reporting high levels of profit.
Positive and negative consequences of the proposed plan for the company and shareholder
Accounting information given by a company should reflect its true financial position. The method above will keep the reputation of the company high, as stakeholders will believe that the accounts portray a true and fair value of the company. Shareholders will rejoice in anticipation of high dividends. However, the truth of the matter is that the company is not performing as indicated in the accounts. It ought to have had reported lower profits. In this case, the danger will come when the company fails to declare high divided as shareholders might anticipate. How the shareholders will see the management will not be pleasant. They might think there is embezzlement of funds in the company and this might be the start of negative perception towards them. The fact that the company has recorded a high profit does not mean it will cater to its financial obligation when they fall due. Therefore, the company is still in financial difficulties.
Does it Comply with accounting standards?
Accounting standards do not dictate the method to be used for the valuation of stock but leave this task to a company. However, it specifies that the method adopted should be consistent. The system can be seen not to violate any standards if we think of it as the start point and in the future, it will be used. However, it is a violation because of its intention. According to accounting ethics, accounts are supposed to report a true and fair financial standing of a company. There should be no manipulation of a kind to manipulate accounts to the benefit of the company as the case in Dhalshun Ltd. On its plane nature, it is a violation of accounting standards.
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