R&R Equipment Company is preparing its annual financial statements in anticipation of applying for a loan. During the last week of the year, R&R received a shipment of inventory but has not paid for it. The invoice indicates that R&R owes $5,000 for the purchase. The owner of R&R, Randy Ray, has decided to omit this asset and the related liability from the year-end balance sheet, reasoning that it is okay because he is omitting both of them, which means there is no difference in owners' equity. For this assignment you are to address the following:
What is your opinion of Randy's reasoning?
Discuss circumstances under which Randy's decision would be acceptable under GAAP and circumstances under which it would definitely be unacceptable.
1. What is your opinion of Randy's reasoning?
I believe that Randy's reasoning is faulty, because omitting this information misrepresents the company's financial picture on the loan application. Even though the value of the asset and the liability cancel each other out, the asset is a tangible shipment while the liability is a monetary debt. The company actually has $5,000 less in liquid capital available than it is stating on the financial statements, since it owes $5,000 for the purchase. Although it does have an asset of equal value, it is unlikely that in the event of a bankruptcy the company would be able to reclaim the full value of the asset in cash. ...
This solution discusses Randy's reasoning in 409 words.