Question

AP2-5

Larry has been the chief financial officer (CFO) of Maxima Auto Service for the past 10 years. The company has reported profits each year it's been in business. However, this year has been a tough one. Increased competition and the rising costs of labor have reduced the company's profits. On December 30, Larry informs Robert, the company's president and Larry's closest friend for the past 10 years, that it looks like the company will report a net loss (total expenses will be greater than total revenues) of about $50,000 this year.

The next day, December 31, while Larry is preparing the year-end reports, Robert stops by Larry's office to tell him that an additional $75,000 of revenues needs to be reported and that the company can now report a profit. When Larry asks about the source of the $75,000, Robert tells lam, "Earlier in the month some customers paid for auto services with cash, and with this cash I bought additional assets for the company. That's why the $75,000 never showed up in the bank statement. I just forgot to tell you about this earlier." When Larry asks for more specifics about these transactions, Robert mumbles, "I can't recall where I placed the customer sales invoices or the purchase receipts for the assets, but don't worry; I know they're here somewhere. We've been friends for a lot of years and you can trust me. Now, let's hurry and finish those reports and I'll treat you to dinner tonight at the restaurant of your choice."

Required

1. Understand the reporting effect: What effect does reporting additional revenue have on reported profit?

2. Specify the options: If the additional revenue is not reported, do both Robert and Larry potentially lose benefits?

3. Identify the impact: Does reporting the additional revenue strengthen the company's financial appearance to those outside the company?

4. Make a decision: Should Larry report the additional revenue without source documents?

Answer 1

1) Effect of reporting additinal revenue on the reported profit:

As on 30 december company's profit and loss account shows $50000 loss in current year

and as on 31 december if company wants to report additional revenue by $75000 in current year

then profit for the year = $75000 - $50000

= $25000 profit

2) If additional revenue is not reported then Robert and Larry potentially lose folowing benefits:

a) Maxima Auto Service is showing profits for the last 10 years and if loss is shown this year then goodwill of the company could be affected

b) It could be the case that shareholders could sell the shares of the company

c) Company could also get delisted from the stock exchange

3) By reporting additional revenue company can strengthen the financial statements to those outside the company but it could have following impacts:

As the reporting of revenue is supportingless then it could be questionable during audit of financial statements.

4) Should Larry report the additional revenue without source documents

No larry should not report because reporting additional revenue could window dress the financial statements but it could tarnish the long term growth of the company because reporting profit without any supporting documents can be questionable during Audit and it could bring stigma on the company.