Question

Glenn's Cleaning Services Company is experiencing cash flow problems and needs a loan. Glenn has a friend who is willing to lend him the money he needs provided she can be convinced that he will be able to repay the debt. Glenn has assured his friend that his business is viable, but his friend has asked to see the company's financial statements. Glenn's accountant produced the following financial statements: Balance Sheet Income Statement Service Revenue $ 38,000 Operating Expenses (70,000 Net Loss $(32,000) $85,000 $35,000 Assets Liabilities Stockholders' Equity Common Stock Retained Eamings Total Liabilities and Stockholders' Equity 82,000 (32,000 $85,000 Glenn made the following adjustments to these statements before showing them to his friend. He recorded $82,000 of revenue on account from Barrymore Manufacturing Company for a contract to clean its headquarters office building that was still being negotiated for the next month. Barrymore had scheduled a meeting to sign a contract the following week, so Glenn was sure that he would get the job. Barrymore was a reputable company, and Glenn was confident that he could ultimately collect the $82,000. Also, he subtracted $30,000 of accrued salaries expense and the corresponding liability. He reasoned that since he had not paid the employees, he had not incurred any expense. Required 1. Reconstruct the income statement and balance sheet as they would appear after Glenn's adjustments. Comment on the accuracy of the adjusted financial statements. Include the restated financial statements (or a worksheet showing the before and after amounts) in your post.

Answer 1

1) ADJUSTED INCOME STATEMENT

PARTICULARS	AMOUNT
SERVICE REVENUE (38000+82000)	120000
(-) OPERATING EXPENSE (70000-30000)	40000
NET INCOME	80000

  BALANCE SHEET

PARTICULARS	ADJUSTED	UNADJUSTED	PARTICULARS	ADJUSTED	UNADJUSTED
ASSETS	85000	85000	LIABILITIES	5000	35000
A/R	82000		COMMON STOCK	82000	82000
			RETAINED EARNING	80000	(32000)
TOTAL	167000	85000	TOTAL	167000	85000

STATEMENT OF CHANGE IN OWNER'S EQUITY

PARTICULARS	AMOUNT
OPENING BALANCE	82000
RETIANED EARNING	80000
CLOSING BALANCE	162000

2)

Adjustment 1: Recognition of Revenue even when the contract has not yet been received
GAAP requires that the following conditions be satisfied before the revenue is recorded in the book:
a. there must have been a critical event that triggered the transaction
b. the amount to be collected from the transaction must be measurable reliably

In the given scenario, the contract itself with Barrymore Manufacturing company has not been signed. Therefore, it is not eligible to be recognized in the books. Hence, I Glenn, would not record this adjustment in the books

Adjustment 2: Accrued Salary expense adjustment
GAAP states that you record revenues and all related expenses in the accounting period in which they occur, whether or not there is an actual movement of funds.
As Accrued salary expense represents the salary earned by the employees but not yet due, the same is required to be accrued in the books.
The explanation that as the same is not yet paid, no expense is incurred, is against the principles of GAAP.
Therefore, I Glenn, would not adjust the books to remove the accrued salary expenses.

3)
For fraud to occur, all three elements must be present i.e. Opportunity,Pressure (also known as incentive or motivation), and Rationalization (sometimes called justification or attitude).

In the case of Glenn, as a owner of the business, he has the opportunity to make adjustments in the books.
Further, because of loss in business, he is under pressure to make fraud adjustments in the books. Glenn is aware that the contract from Barrymore is secured and because of fake adjustments he will get loan amount for his business. Therefore, he has a justification to make fraud adjustments in the books.