Ethics and inventory obsolescence (adapted from CMA exam). The external auditors of E ndosonycs are currently performing their annual audit of the company with the help of assistant controller Tony Martinez. Several years ago Endosonycs developed a u nique balloon technique for opening obstructed arteries in the heart. The technique utilizes an expensive component that Endosonycs produces. Until last year, Endosonycs maintained a monopoly in this field.

During the past year, however, a major competitor developed a technically superior product that uses an innovative, less costly component. The competitor was granted FDA approval, and it is expected that Endosonycs will lose market share as a result. Endosonycs currently has several years' worth of expensive components essential for the manufacture of its balloon product. Tony Martinez knows that these components will decrease in value due to the introduction of the competitor's product.

He also knows that his boss, the controller, is aware of the situation. The controller, however, has informed the chief financial officer that there is no obsolete inventory nor any need for reductions of inventories to market values. Tony is aware that the chief financial officer's bonus plan is tied directly to the corporate profits which depend on ending inventory valuations.

In signing the auditor's representation letter, the chief financial officer acknowledges that all relevant information has been disclosed to the auditors and that all accounting procedures have been followed according to generally accepted accounting principles. Tony knows that the external auditors are unaware of the inventory problem, and he is unsure of what to do.

a. Has the controller behaved unethically ?

b. How should Tony Martinez resolve this problem? Should he report this inventory overvaluation to the external auditors?