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Jerry Maloney, CPA has been working at Mason Pharmaceuticals for 1 5 years. Mason is a Fortune 1 0 0 0 company whose stock trades
Jerry Maloney, CPA has been working at Mason Pharmaceuticals for years. Mason is a Fortune company whose stock trades on the New York Stock Exchange. He
came to Mason after starting his career in the audit practice of PwC working on clients in the Pharmaceuticals and Medical Device manufacturing industries. Jerry loves
and is very loyal to both the industry he works in and the company he works for. He believes that the drugs they manufacture save lives and he is committed to the
continued success of the company. He started out as an Assistant Manager of Internal Audit at Mason, later led the internal audit division, and then moved into the
Financial Reporting Department. His hard work has paid off and he was recently promoted to Senior Manager of Financial Reporting, reporting directly to the CFO. His
department is responsible for preparing and ensuring the accuracy of all the required filings to the SEC and the NYSE. While his boss must certify the accuracy of the
financials, the CFO relies on Jerry to ensure compliance with GAAP and that all the reporting requirements of the SEC and the NYSE are followed.
Jerry is sitting in his office reviewing a preliminary draft of the for the third quarter ended September He is smiling as he reads the report as their Earnings
Per Share EPS figures have exceeded their projected numbers for the third quarter in a row and he knows upper management will be thrilled. As he sits and contemplates
what this might mean in terms of bonuses, raises, and stock valuation, Sharon Diggins, the Manager of Financial Reporting, knocks on his door. He invites her in and she
explains that their staff have just found a material understatement of expenses in the draft Q She explains that Research and Development Costs on a new drug to treat
Colorectal Cancer had been inadvertently capitalized as direct materials inventory and they needed to reverse that entry before issuing a final Q with the SEC. The
reversal will cause them to fall just short of their expected EPS figures.
Mason is waiting for approval of the new drug by the US Food and Drug Administration FDA that is expected in the fourth quarter. The company expects this new drug
to produce more revenue than any drug they have manufactured to date. Sharon explains that the purchasing manager had inadvertently purchased a six months supply of
the primary compound needed to produce the drug starting in the third quarter. The accounts payable clerk recorded the invoice for the compound as Direct Materials
Inventory as the intent was to use the materials for the manufacture of the new drug. Under GAAP all such costs need to be expensed as Research and Development Costs
up until regulatory approval is received.
Jerry is distraught over the fact that the internal audit department did not catch this error sooner. He discusses with Sharon that they will need to investigate the oversight
later but right now their larger issue is getting the reports revised. He explains that convincing John Bender, the CFO, that they need to correct this error now will be
difficult. Bender is also reviewing the same draft of the Q that Jerry has and must be delighted by the apparent results. Jerry is sure he will argue against expensing the
cost of the compound. He can just imagine that at a minimum Bender will argue that following GAAP to the letter does not make sense. The intent of the purchase was to
produce the drug, which they had started doing in the current quarter. He is sure Bender will state following GAAP will actually reduce the true cost of goods sold next
quarter and, therefore, they should leave the cost in inventory. Besides, he will argue, regulatory approval will be forthcoming. Sharon reminds Jerry that capitalizing the
costs reduces cost of goods sold in the current quarter and, consequently, overstates gross profit, a violation of GAA. The SEC will consider it fraudulent financial and we
cannot allow that to happen. She suggests that they put their GVV training to work and try to identify all the arguments that Bender will use to try and convince them to
ignore this error and then prepare counter arguments. Jerry agrees and they get to work formulating their plan for discussing this matter with Bender.
What are the main arguments that Jerry and Sharon will need to counter? That is what are the reasons and rationalizations they will need to address?
What is at stake should they not convince Bender to issue a revised
What levers do Jerry and Sharon have available to them? Include in your answer a discussion of the provisions under SOX and how they might be used as a lever.
If they cannot convince Bender to issue the revised report, what is their next step? To whom should they report this matter to Include other parties they might be able to involve who will support their position.
If they are unable to stop the draft report from being issued, what are their options?
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