ARRANGING FOR PRIOR PERIOD ADJUSTMENTS. Beth Rader, one of the junior accountants for Microbox, Inc., is concerned about the firm’s more recent financial statements. Beth was responsible for developing the information for the firm’s cost of goods sold calculation. As a part of that work, Beth supervised the physical inventory and is confident that the amount she developed, $2,355,000, is reasonable. However, when Beth received a copy of the financial statements, she noted that the ending inventory is reported at $3,255,000 and that cost of goods sold is $900,000 lower than the amount she calculated. This change in cost of goods sold caused Microbox to report a substantial profit rather than a small loss for the year.

Beth approaches the controller with her concern. The controller advises Beth that he will look into the matter. Several weeks later he advises Beth that Microbox’s financial vice president claimed that he had transposed Beth’s numbers. The controller wonders whether the transposition was inadvertent. At the time that the financial statements were released with this error, Microbox’s stock price had been badly depressed. The financial vice president said that he would authorize a prior period adjustment to correct this error. Coincidentally, the market price of the Microbox stock is no longer depressed.

REQUIRED:

1. If this was an inadvertent error, is a prior period adjustment the proper way to correct the mistake? (Hint: Read paragraph 13 of Accounting Principles Board Opinion No. 20.)

2. Why might the financial vice president think that a prior period adjustment reducing retained earnings by $900,000 (less the applicable income taxes) would be less visible than a $900,000 expense?