Q1EI - Horngren'S Financial And Managerial Accounting

Question

The net income of Steinbach & Sons, a landscaping company, decreased sharply during 2018. Mort Steinbach, owner and manager of the company, anticipates the need for a bank loan in 2019. Late in 2018, Steinbach instructs the company’s accountant to record \(2,000 service revenue for landscape services for the Steinbach family, even though the services will not be performed until January 2019. Steinbach also tells the accountant not to make the following December 31, 2018, adjusting entries:

 

Salaries owed to employees \) 900

Prepaid insurance that has expired 400

 

Requirements

1. Compute the overall effects of these transactions on the company’s reported net income for 2018.

2. Why is Steinbach taking this action? Is his action ethical? Give your reason, identifying the parties helped and the parties harmed by Steinbach’s action.

3. As a personal friend, what advice would you give the accountant?

Step-by-Step Solution

Answer

The action in the given case is not ethical and net income has been overvalued by $3,300.

Step 1: Overall effects of the transactions

As the salaries owed to employees and prepaid insurance have not been recorded, the adjustment for these transactions would reduce the net income. Furthermore, the unearned revenue recorded in 2018 would also reduce the net income. 

The net effect would be as follow –

 

Net Income	XXXX
Less: Outstanding Salary	$    900
Expired Prepaid Insurance (Insurance expense)	400
Unearned revenue	2,000
Adjusted Net Income	Net Income     -  $3,300

 

So the net income would reduce by $3,300 amount.

Step 2: Ethical Issue

Steinbach is taking this action to overvalue the net income. By doing so the expense would be undervalued and revenue would be overvalued. The net result would be an overvaluation of net income.

No, the action is not ethical as the accounting practice is not followed. The matching principle is ignored here which says all revenues and expenses for the year must be accounted for in that year only.

Step 3: Recommendation

In the given case, the recommendation is only the adoption of accounting practice and concepts. Furthermore, the accountant should not be influenced by his decision and be independent to follow best accounting practices.