The external auditors of Heart Scientific are currently performing their annual audit of the company with the help of assistant controller Tino Mariano. Several years ago Heart Scientific developed a unique balloon technique for opening obstructed arteries in the heart. The technique utilizes an expensive component that Heart Scientific produces. Until last year, Heart Scientific 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 Heart Scientific will lose market share as a result. Heart Scientific currently has several years’ worth of expensive components essential for the manufacture of its balloon product. Tino Mariano 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. Tino 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. Tino 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 Tino Mariano resolve this problem? Should he report this inventory overvaluation to the external auditors?