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Reliable Provision Company: Overstated or understated Income

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The net income of Reliable Provision Company decreased sharply during 2007. Clay Rollins, owner of the store, anticipates the need for a bank loan in 2008. Late in 2007, he instructed the accountant to record a $70,000 sale of recreational gear to the Smith family, even though the goods will not be shipped from the manufacturer until January 2008. Rollins told the accountant not to make the following adjusting entries:

Salary owed to employees: $1,000

Expired prepaid insurance: $500

Is income overstated or understated? Why did Rollins take these actions? Are they ethical? Give reasons for your answer. As a friend, what advice would you give the accountant?

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Solution Summary

The solution explains the reasons and the effects of ignoring the two adjusting entries.

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Clay Rollins is anticipating applying for a bank loan in 2008, and he knows that the bank will ask for financial statements from the prior year - 2007. His plan is to make his company look better than it really is by inflating income and not reporting all the expenses. He justifies that action by saying to himself that the sale pushed back to 2007 will happen within just a few weeks of year-end, so no harm done.

It's a common rationale that ignores the concept of ...

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