Ethical Dilemma Would I lie to you, baby?
Andy and Jean Crocket are involved in divorce proceedings. When discussing a property settlement, Andy told Jean that he should take over their investment in an apartment complex because she would be unable to absorb the loss that the apartments are generating. Jean was somewhat distrustful and asked Andy to support his contention. He produced the following income statement, which was supported by a CPA’s unqualified opinion that the statement was prepared in accordance with generally accepted accounting principles.
CROCKET APARTMENTS Income Statement For the Year Ended December 31,2011 | ||
Rent revenue |
| $580,000 |
Less: Expenses |
|
|
Depreciation expense | $280,000 |
|
Interest expense | 184,000 |
|
Operating expense | 88,000 |
|
Management fees | 56,000 |
|
Total expenses |
| (608,000) |
Net loss |
| $(28,000) |
All revenue is earned on account. Interest and operating expenses are incurred on account. Management fees are paid in cash. The following accounts and balances were drawn from the 2010 and 2011 year-end balance sheets.
Account Title | 2010 | 2011 |
Rent receivable | $40,000 | $44,000 |
Interest payable | 12,000 | 18,000 |
Accounts payable (oper. exp.) | 6,000 | 4,000 |
Jean is reluctant to give up the apartments but feels that she must do so because her present salary is only $40,000 per year. She says that if she takes the apartments, the $28,000 loss would absorb a significant portion of her salary, leaving her only $12,000 with which to support herself She tells you that while the figures seem to support her husband’s arguments, she believes that she is failing to see something. She knows that she and her husband collected a $20,000 distribution from the business on December 1, 2011. Also, $150,000 cash was paid in 2011 to reduce the principal balance on a mortgage that was taken out to finance the purchase of the apartments two years ago. Finally, $24,000 cash was paid during 2011 to purchase a computer system used in the business. She wonders, “If the apartments are losing money, where is my husband getting all the cash to make these payments?”
Required
a. Prepare a statement of cash flows for the 2011 accounting period.
b. Compare the cash flow statement prepared in Requirement a with the income statement and provide Jean Crocket with recommendations.
c. Comment on the value of an unqualified audit opinion when using financial statements for decision-making purposes.
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