AP2-5 Larry has been the chief

AP2-5

Larry has been the chief financial officer (CFO) of Maxima AutoService for the past 10 years. The company has reported profitseach year it’s been in business. However, this year has been atough one. Increased competition and the rising costs of labor havereduced the company’s profits. On December 30, Larry informsRobert, the company’s president and Larry’s closest friend for thepast 10 years, that it looks like the company will report a netloss (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-endreports, Robert stops by Larry’s office to tell him that anadditional $75,000 of revenues needs to be reported and that thecompany can now report a profit. When Larry asks about the sourceof the $75,000, Robert tells lam, “Earlier in the month somecustomers paid for auto services with cash, and with this cash Ibought additional assets for the company. That’s why the $75,000never showed up in the bank statement. I just forgot to tell youabout this earlier.” When Larry asks for more specifics about thesetransactions, Robert mumbles, “I can’t recall where I placed thecustomer sales invoices or the purchase receipts for the assets,but don’t worry; I know they’re here somewhere. We’ve been friendsfor a lot of years and you can trust me. Now, let’s hurry andfinish those reports and I’ll treat you to dinner tonight at therestaurant of your choice.”

Required

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

2. Specify the options: If the additional revenue is notreported, do both Robert and Larry potentially lose benefits?

3. Identify the impact: Does reporting the additional revenuestrengthen the company’s financial appearance to those outside thecompany?

4. Make a decision: Should Larry report the additional revenuewithout source documents?

Answer:

1) Effect of reporting additinal revenue on the reportedprofit:

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

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

then profit for the year = $75000 – $50000

= $25000 profit

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

a) Maxima Auto Service is showing profits for the last 10 yearsand if loss is shown this year then goodwill of the company couldbe affected

b) It could be the case that shareholders could sell the sharesof the company

c) Company could also get delisted from the stock exchange

3) By reporting additional revenue company can strengthen thefinancial statements to those outside the company but it could havefollowing impacts:

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

4) Should Larry report the additional revenue without sourcedocuments

No larry should not report because reporting additional revenuecould window dress the financial statements but it could tarnishthe long term growth of the company because reporting profitwithout any supporting documents can be questionable during Auditand it could bring stigma on the company.


 
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