Below is a hypothetical Unadjusted Balance Sheet and Income Statement for the year ended December 31, 2012. Additional information is provided allowing the preparation of both an Adjusted Balance sheet and Income Statement, making decisions under different sets of assumptions based on their assigned role:

BALANCE SHEET

AT DECEMBER 31, 2012 (UNADJUSTED)

ASSETS:		LIABILITIES:
Current assets:		Current liabilities:
Cash	$14,740	Accounts payable	$50,468
Accounts receivable (less allowance)	24,039	Unearned revenue	10,000
Inventory	1,569,500	Total current liabilities	60,468
Prepaid Insurance	24,000	Long-term liabilities:
Total current assets	1,632,279	Notes Payable	250,000
		Total Liabilities	310,468
Long-term assets:
Property and equipment (less: accumulated depreciation)	500,000	STOCKHOLDERS EQUITY:
Patent	5,000	Common stock, no par	251,676
Total long-term assets	505,000	Retained Earnings	1,575,135
		Total Stockholders equity	1,826,811
TOTAL ASSETS	$2,137,279	TOTAL LIAB. AND EQUITY	$2,137,279

INCOME STATEMENT

FOR THE YEAR-ENDED DECEMBER 31, 2012 (UNADJUSTED)

Sales	$2,233,109
Less: selling and admin expenses	655,974
Lease expense	2,000
NET INCOME	$1,575,135

Additional Information:

* Prepaid Insurance was paid on January 1, 2012. The policy offers coverage for two years.

* Unearned Revenue represents a deposit received from a customer on December 20, 2012. The customer has received part of the order. One item costing $2,000 is on backorder and has not been shipped to the customer yet.

* A one-year Note Payable for $250,000 was obtained on September 1, 2012. The interest rate is 8%. All principal and interest are due on September 1, 2013.

* The gross amount of Accounts Receivable totaled $24,039. (The firms credit policy requires payment within 60 days). Industry guidelines indicate uncollectible accounts are generally in the range of 1 to 12% of the ending accounts receivable balance. (Note that management very often sets percentages based on an aging schedule, not just on the total accounts receivable balance, but for ease of presenting solutions these percentages will be used).

* The company uses Straight-Line Depreciation for its Plant and Equipment. Plant and Equipment costs consist of the following:

Building 350,000 (range 30 to 40 years)

Furniture 130,000 (range 10 to 20 years)

Computers 20,000 (range 2 to 5 years)

TOTAL 500,000

* Inventory costs are as follows:

Purchase Date	Units	Unit price	Total price
1/1/12	500	385	192,500
3/1/12	400	415	166,000
5/1/12	700	450	315,000
8/1/12	500	490	245,000
10/1/12	600	525	315,000
12/1/12	600	560	336,000
	3,300		1,569,500
Units sold	2,900
Units left	400

* Most products sold include a one-year warranty. Industry guidelines indicate warranty costs represent about 1-3% of sales revenue.

* The company purchased a patent for $5,000 on January 1, 2012 with a remaining legal life of 10-years. However, estimated cash flows each year, over the next 10 years, are on average $500 per year. The incremental borrowing rate used to discount these cash flows to present value should be 8% a year. The present value is therefore, $500 x (PVIFA, n=10, i=8%) = $500 x (6.7101) = $3,355.

* On January 1, 2012 the company signed a 5-year lease for a copier requiring payments of $500 at the end of each quarter (March 31, June 30, Sept. 30 and Dec. 31). The market value of the copier is estimated to be between $9,000 and $9,500. At the purchase date, the present value of the minimum lease payments using an 8% annual rate is: $500 x (PVIFA, n=20, i=2%) = $500 x (16.3514) = $8,176. The unadjusted financial statements currently show the impact of the lease payments as an operating lease ($500 * 4 = $2,000).

REQUIREMENTS OF THE CASE

Task: Prepare an adjusted Income Statement and Balance Sheet. Use a statutory tax rate of 35% to record income taxes payable and income tax expense.

YOU MAY CHOSE TO BE EITHER AN AGGRESSIVE MANAGER OR A CONCERVATIVE MANAGER

If you are an aggressive manager you should choose estimates to report the highest Net Income possible since:

1. Management may receive higher bonuses based on favorable financial results.
2. If reported Net Income is above analysts expectation of net income, then share price may increase and managements stock options and stock holdings will increase in value. However, if reported earnings are below expectations investors are disappointed and stock prices may fall (Brown and Caylor, 2005).
3. Management may have minimum ratios to maintain according to debt covenants in their borrowing agreements. This gives them an incentive to manage income in order to avoid debt-covenant violations.

If you are a conservative manager you should choose estimates to avoid overstating results for shareholders and potential investors since:

1. The market may value more conservative earnings numbers. Aggressive earnings management is unsustainable in the long run.
2. The new CEO may be shifting costs to the current period from the future periods in order to record less expense and report higher income in future years. This allows the new management to blame poor current performance on prior management and take a big bath (rid the Balance Sheet of costs that would otherwise be experienced in the future).