Question

Scenario: It is the end of 2019 and you are an accountant for Stone Company. During 2019, sales of the company's products slumped and the company's earnings are expected to be much less than those of 2018. The president comes to you with an idea. He says, "Our company's property, plant, and equipment cost $300,000, and that is the amount we usually report on our balance sheet. However, I just had these assets appraised by an independent appraiser, and she says they are worth $400,000. I think that the company should report the property, plant, and equipment at this amount on its December 31, 2019, balance sheet and should report the $100,000 increase in value as a gain on the 2019 income statement. If we use this approach, it will show how much our company is really worth and increase our earnings. This will make our shareholders happy. What do you think?"

How would you respond to the president?

Answer 1

The president's decision to inflate the profit figures by increasing the value of the assets and recording it as a gain in the income statement is certainly against the GAAP principles. As per GAAP , an upward revision to the asset cost after it is acquired is not permitted and only the asset must be tested for impairment. The company uses the cost method i.e. reporting at historical cost and no changes to the plant, property and equipment must be done. It is uncertainly unethical for the president to present a rosy picture of the accounts when the reality is different. Also, window dressing of accounts will only lead to temporary financial gains and must not be encouraged. The same will be questioned and discovered during external audit and the auditor may flag off the transaction as a risk and qualify the audit report. This will in turn be questioned by the SEC and may result in loosing the trust and faith of the stakeholders. The president must be explained of the consequences and prevailing guidelines as outlined earlier and the profit figures must not be inflated.