Errors in Financial Statements
The following financial statements are available for Sherwood Real Estate Company:
Balance Sheet
Assets Liabilities
- Cash . . . . . . . . . . . . . . $ 1,300 Accounts payable . . . . . . . . $ 100,000
- Receivable from sale of
- real estate. . . . . . . . . 5,000,000 Mortgage payable. . . . . . . .
- Total liabilities . . . . . . . . . . . 6,000,000
- $ 6,100,000
- Interest receivable*. . . . 180,000
- Real estate properties . . 6,000,000
- Stockholders' Equity
- Capital stock. . . . . . . . . . . . $ 10,000
- Retained earnings . . . . . . . . 5,071,300
- Total stockholders' equity. . . 5,081,300
- Total assets . . . . . . . . . $11,181,300 Total liabilities and
- sto ckholders' equity. . . . . $11,181,300
- *Interest Receivable applies to Receivable from sale of real estate.
- Income Statement
- Gain on sale of real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,200,000
- Interest income*. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180,000
- Total revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $3,380,000
- Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200,000
- Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,180,000
*Interest Income applies to Receivable from sale of real estate.
Sherwood Company is using these financial statements to entice investors to buy stock in the company. However, a recent FBI investigation revealed that the sale of real estate was a fabricated transaction with a fictitious company that was recorded to make the financial statements look better. The sales price was $5,000,000 with a zero cash down payment and a $5,000,000 receivable.
Prepare financial statements for Sherwood Company showing what its total assets, liabilities, stockholders' equity, and income really are with the sale of real estate removed.
Appropriateness of Accounting Rules In the early 1990s, the top executive of a large oil refining company was convicted of financial statement fraud. One of the issues in the case involved the way the company accounted for its oil inventories. The company would purchase crude oil from exploration companies and then process the oil into finished oil products, like jet fuel or diesel fuel. Because there was a ready market for these finished products, as soon as the company purchased the crude oil, it would value its oil inventory
at the selling prices of the finished products less the cost to refine the oil. This type of accounting was questioned because it allowed the company to recognize profit before the actual sale (and even refining) of the oil. Nevertheless, one of the large CPA firms attested to the use of this method. If you were the judge in this case, would you be critical of this accounting practice?