Far from being an exact science, accounting involves estimation and judgment. Consider the case of Dwight Nelson, chief financial officer of Pilot Enterprises. Pilot is a relatively young, privately held company with thoughts of going public in the near future. The owners of the business would like to include in the prospectus (a document containing information about the company and its past performance) financial statements that support their assertion that Pilot is a successful company with a bright future.
The problem is the income statement for the past year shows a slight decrease in income from the prior period. When Dwight presented this information to the board of directors, he was told to revise the income statement. He was specifically counseled to review his estimates associated with bad debt expense, warranty expense, and estimated useful life of depreciable assets. He was invited to present his "revised" income statement to the board when it showed a 5% increase over last period's net income - anything less would not do.
After reviewing the assumptions made regarding uncollectibles, warranties, and depreciation, Dwight found that he could revise his estimates and obtain the 5% target increase in income. But he did not feel that the revised income statement properly reflected the performance of Pilot for the period.
1. What are the risks to Dwight of revising the income statement to meet the target?
2. What are the risks to Dwight of not revising the income statement?