The fraud triangle The accounting records of Masterson Manufacturing Company (MMC) revealed that the company incurred $3 million of materials, $5 million of production labor, $4 million of manufacturing overhead, and

$6 million of general, selling, and administrative expense during 2008. It was discovered that MMC’s chief financial officer (CFO) included $2.6 million dollars of upstream research and development expense in the manufacturing overhead account when it should have been classified as general, selling, and administrative expense. MMC made 5,000 units of product and sold 4,000 units of product in 2008.

Required

a. Indicate whether the elements on the 2008 financial statements (i.e., assets, liabilities, equity, revenue, expense, net income, and cash flow) would be overstated or understated as a result of the misclassification of the upstream research and development expense. Determine the amount of the overstatement or understatement for each element.

b. Speculate as to what would cause the CFO to intentionally misclassify the research and development expense. (Hint: Review the chapter material regarding the fraud triangle.)