Question

Brent Robertson and his banker were reviewing the quarterly income statements for his consulting business, Robertson and Associates, Inc. The banker was impressed with the growth of sales revenue and net income for the second quarter of this year compared with the second quarter of last year. Brent knew it had been a good quarter, but he didn't think it had been spectacular. Suddenly, Brent realized that he failed to close out the revenue and expense accounts for the prior quarter, which ended in March. Because those temporary accounts were not closed out, their balances were included in the second quarter amounts for the current year. Brent then realized that the banker had the financial statements but not the general ledger or any trial bal- ances. Thus, the banker would not be able to see that the accounting cycle from the first quarter was not properly closed and that this failure was creating a misstated income statement for the second quarter of the current year. The banker then commented that the business seemed to be performing so well that he would approve a line of credit for the business. Brent decided to not say anything because he did not want to lose the line of credit. Besides, he thought, it really did not matter that the income statement was misstated because his business would be sure to repay any amounts borrowed.

Should Brent have informed the banker of the mistake made? should he have redone the second quarter's income statement ? was Brent's failure to close the prior quarter's revenue and expense accounts unethical? Does the fact that the business will repay the loan matter?

Answer 1

In the given case, Brent has presented misstated financial statements to his banker. The revenue and expenses of previous quarter have been included in the current quarter, which makes the banker believe that the business has been performing pretty well. Brent did not disclose the real facts to banker because he believed that he would be able to repay any amounts borrowed.

1. Brent should have informed the banker the mistake he made. If he does not inform the same to banker, it could have later repercussions. For example, if annual accounts are presented at the end of the year, this mistake could be easily revealed to the banker.
2. Brent should also have asked for further time to prepare the second quarter’s income statement once again. By doing this, fair accounts would be presented to the banker, and he would be more confident to grant the facility the next time, because of the trust factor.
3. Brent’s failure to disclose the prior quarter’s revenue and expense accounts was unethical. It could also bring a bad goodwill to the company name.
4. The business will be able to repay the loan would not matter in as much because, the next time the financials are presented, it would result in revelation in the mistake. Also, bankers would think more than twice to grant loans or any such credit facility to the company.