Question

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The president of your company wants you to count merchandise inventory from the factory in preparation for a visit from stockholders. The president asks you to make the inventory a bit heavy by counting one row twice to cause the net income to show a higher number. What should you do?

Okay let's talk first about what we are not interested in:

1) Your moral compass or ethics. I'm not being sarcastic but it really doesn't matter in this instance. We don't care about whether you personally think it is right or wrong. The only thing that matters is GAAP-and whether we are accurately reporting if we do this.

2) Reporting to anyone, law enforcement, SEC, upper management. We aren't going to have a conversation about reporting it to anyone and documenting this request. It doesn't matter. These types of issues are almost never a legal issue anyway.  

3) Effects on financial statements in vague terms such as "thrown off", "out of balance", or any other term that does not state specifically how the statement is inaccurate.

Here's what we do care about:

1) What does GAAP principles say about this type of action?

2) How is the income statement affected? Is gross profit understated or overstated or just right? Is net income overstated or understated or just right? Is the balance sheet correct? If not, what account(s) are off specifically. For example, you can't just say assets-you have to say exactly which asset. You can't just say equity, you have to say which equity account. Are they overstated or understated?  

Answer 1

1) What does GAAP principles say about this type of action?

Answer:-

Principle of Sincerity, which is one of the main Principle in Generally Accepted Accounting Principles (GAAP), Accountant should prepare accounts in such way that they should represent the true and fair view of the financial status of the Business organization. So, counting twice the inventory rows is against the principle of Sincerity in GAAP. And also this type of action is unethical, as the company is trying to deceive the stake holders of the Company.

2)  How is the income statement affected? Is gross profit understated or overstated or just right? Is net income overstated or understated or just right? Is the balance sheet correct? If not, what account(s) are off specifically.

Answer:-

By counting twice the rows of inventory, closing balance of Inventory will increase, which raises the Gross profit and also Net profit. i.e Gross profit will be Overstated. And net income will also overstated because of the same effect. The Balance sheet will show wrong balance. Because the net profit which was wrongly overstated will raise the ' Surplus funds or balance from profit and loss account' and it will increase the share holder's funds, and at the same time the opposite side i.e Inventory under current assets will also raised. The balance sheet represents wrong financial position of the company with wrong overstated balances.