O'MALLEY CORPORATION INCOME STATEMENT
Sales revenue		$850,000
Dividends		32,300
Gain on recovery of insurance proceeds from earthquake loss		38,500
		920,800
Less:
Selling expenses	$101,100
Cost of goods sold	510,000
Advertising expense	13,700
Loss on obsolescence of inventories	34,000
Loss on discontinued operations	48,600
Administrative expense	73,400	780,800
Income before income tax		140,000
Income tax		56,000
Net income		$84,000

CA 4-2, p. 190

Instructions

Indicate the deficiencies in the income statement presented above. Assume that the corporation desires a single-step income statement.

CA4-2 GROUPWORK (Earnings Management) Bobek Inc. has recently reported steadily increasing income. The company reported income of $20,000 in 2014, $25,000 in 2015, and $30,000 in 2016. A number of market analysts have recommended that investors buy the stock because they expect the steady growth in income to continue. Bobek is approaching the end of its fiscal year in 2017, and it again appears to be a good year. However, it has not yet recorded warranty expense.

Based on prior experience, this year's warranty expense should be around $5,000, but some managers have approached the controller to suggest a larger, more conservative warranty expense should be recorded this year. Income before warranty expense is $43,000. Specifically, by recording a $7,000 warranty accrual this year, Bobek could report an increase in income for this year and still be in a position to cover its warranty costs in future years.

Instructions

(a)What is earnings management?

(b)Assume income before warranty expense is $43,000 for both 2017 and 2018 and that total warranty expense over the 2-year period is $10,000. What is the effect of the proposed accounting in 2017? In 2018?

(c)What is the appropriate accounting in this situation?