WRENCROFT APPLIANCE COMPANY
In 1989, Auditors of Wrencroft Appliance Company (WAC) proposed two different inventory write-downs regarding a discontinued microwave product and spare parts to the company’s audit committee. John Moore, WPC‘s CFO, is in the position to make recommendations to the board regarding the proposed adjustments. He needs to make a careful evaluation of whether the proposed inventory write-downs are necessary for the independent accountants to render unqualified opinion. In order to make sound recommendations to audit committee, John should analyze on the following matters.
1.) Are the reflected amounts in the proposed write-downs based on reasonable ...view middle of the document...
Writing off the price difference of selling it to discount chain is a good proposal in order to unload the risk of carrying slow-moving item plus the tax deduction benefit. Moreover, Another thought to be considered is donating the discontinued microwave units to a charitable institution would both create good PR for independent company while still availing huge tax deduction benefit based on the full of amount of the total bulk of dead inventory that the company would risk to carry.
Spare Parts Valuation
The adjustment treatment that the audit proposed was to reduce spare parts’ estimated life usage by 15% from its total production by year. Proposed amount to be written-off is $1,800,000 may not be reasonable and necessary considering the nature of spare parts in historical data that it can hamper the existing customer service relationship nature they have developed over the years that the spare parts are readily available, the revaluation of the excess of inventory pointed out in the proposal may not be reflective of its true realizable value should they decide to write it off, according to the argument pointed out by the line managers the nature of spare parts reduction has little effect on sales volume. The effect of income tax deduction for this proposal is a controlling factor that may not be reasonable since the amount to be written off in the book value of the existing inventory may actually be greater that the 15% price reduction you are going to give up for tax purposes. Note that the excess in the inventory of spare parts can also be an enviable reputation for customer service should there be market demand for spare parts in the future. WAC did not create policy in accounting for spare parts inventory, instead of writing it off, John can justify this by creating an inventory policy for the accounting spare parts on hand instead of writing it off in the 1988 fiscal year.
Income tax implication vs Write-down proposals
The underlying concept of tax deduction benefit for companies like WAC who recognized that writing off the discontinued and excess inventory may be true for slow moving items like microwave inventory. However, it will be difficult to justify for the spare parts. GAAP states that the inventory should be valued at the lower of cost or market. Excess, slow moving and obsolete inventory may be valued at lower than cost or market only in compliance with IRS regulations. The regulations require that such inventory either be offered for sale at the reduced price or that such inventory be sold at reduced prices like the case of microwaves. However in the case for spare parts there is no pervasive evidence in the case presented that the market value of the spare parts inventory has diminished to a level below its cost. While this reduction in the inventory may be desirable for tax purposes, it will be burden for WAC if the spare parts will still be retained in the inventory. Writing off the spare...