Micro Warehouse is a computer software and hardware online and catalogue sales company.} A Wall Street Journal article disclosed the following:Its quarterly report filed with the Securities and Exchange Commission two days before indicated that inaccuracies involving understatement of purchases and trade payable in current and prior periods amounted to \(\$ 47.3\) million. It also indicated that, as a result, \(\$ 2.2\) million of executive bonuses for 1995 would be cancelled. Micro Warehouse's effective tax rate is approximately 40.4 percent. Both cost of sales and executive bonuses are fully deductible for tax purposes.

Required:

As a new staff member at Micro Warehouse's auditing firm, you are assigned to write a memo outlining the effects of the understatement of purchases and the cancellation of the bonuses. In your report, be sure to include the following:

1. The total effect on pretax and after-tax earnings of the understatement of purchases.

2. The total effect on pretax and after-tax earnings of the cancellation of the bonuses.

3. An estimate of the percentage of after-tax earnings that management is receiving in bonuses.

4. A discussion of why Micro Warehouse's board of directors may have decided to tie managers' compensation to reported earnings and the possible relationship between this type of bonus scheme and the accounting errors.