You work as an accountant for a small land development company that desperately

Question

You work as an accountant for a small land development company that desperately needs additional financing to continue in business. The president of your company is meeting with the manager of a local bank at the end of the month to try to obtain this financing. The president has approached you with two ideas to improve the company’s reported financial position. First, he claims that because a big part of the company’s value comes from its knowledgeable and dedicated employees, you should report their Intellectual Abilities as an asset on the balance sheet. Second, he claims that although the local economy is doing poorly and almost no one is buying land or new houses, he is optimistic that eventually things will turn around. For this reason, he asks you to continue reporting the company’s land on the balance sheet at its cost, rather than the much lower amount that real estate appraisers say its really worth.

Required: Comment on the following questions. Why do you think the president is so concerned with the amount of assets reported on the balance sheet? What accounting concept relates to the presidents first suggestion to report Intellectual Abilities as an asset? What accounting concept relates to the presidents second suggestion to continue reporting land at its cost? Who might be hurt by the presidents suggestions, if you were to do as he asks? What should you do?

Explanation / Answer

President is so concerned for the amount of assets reported on the Balance sheet because for obtaining financing from local bank he has to present in the bank all the financial statements of the company. For obtaining finance it is imperative that all the financial statements must be fairly prepared and must reflect a sound position of the business. The most important statement which bank will consider is balance sheet. It shows the position of assets and liabilities of the business at a given point of time. Assets are the indicator of the short term liquidity and long term solvency of a company. Bank when deciding about the financing decision will be interested to know the liquidity and solvency position of the company so that they can ensure return of their money. That is why it is necessary to present a sound position of assets before the bank and for this reason, president is so concerned about the amount of assets.

Money Measurement concept is related with the President's first suggestion. According to this concept only those things which can be reported in money terms should appear in financial statements. So, the knowledgable employees cannot be expressed in money's worth hence they cannot be entered in financial statements.

In the second suggestion, cost concept is involved which suggest that all the assets must be record in financial statements on their cost. All the parties concerned with the company like stockholders, society, employees, bank will be hurt by the adoption of unfair policy of reporting financial statements against the rules of accounting. This will be against the ethics of the business. So, as an accountant I will not encourage this practice and would not be involved in this.

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