Question

Lynne Jamison was recording the daily transactions of Liberty Physical Therapy, Inc., into the accounting records so she could prepare financial statements and apply for a bank loan. Some of the business expenses were higher than she expected, and Lynne was worried about the effect of these expenses on net income. Lynne was recording a $3,800 payment for legal fees incurred by the business by debiting Legal Expense and crediting Cash to properly record the journal entry. She then thought that, rather than debiting the expense account for the $3,800 payment, she could debit the Dividends account, which also had a normal debit balance. Lynne knew that debits had to equal credits, so debiting the Dividends account instead of the Legal Expense account would not affect the trial balance. Further, the net income would be $3,800 higher because now no legal expense would be recorded. She thought that either way the retained earnings would be lower, and besides, it really didn’t matter how the $3,800 payment was shown as long as it appeared somewhere. Should Lynne debit the Dividends account rather than the Legal Expense account? Do you agree that it really doesn't matter how the #3,800 payment is shown, as long as it appears somewhere? Considering that Lynne owns all of the Liberty Physical Therapy, Inc., common stock, does she have any ethical responsibilities to properly record each business transaction?

Answer 1

Answer:

Disagree with Lynne, as she is representing a misstatement.

It is the ethical responsibility either of Lynne or anyone to show the true and fair view of company's financial statement, that is the financial statement are free from material misstatements and faithfully represents the financial performance and position of the entity.

Here, she cannot debit the dividend accounts instead of Legal expenses in order to higher the net income as its one of the responsibilities of the directors of the company to show the perfect picture of the financial statement.

Hence, she should show legal expenses on debit side which will reflect the actual net income earned by the company.