Running head: Case in Technical and Ethical Issues of Accounng
Honest and accurate record keeping and accounting are essential attributes to
any business that hopes to be successful in the long run. The GAAP (Generally
Accepted Accounting Principles) set guidelines for a majority of U.S. businesses that
ultimately aim to, “…ensure companies produce financial information that is useful to
existing and potential investors, lenders and other creditors,” and “…must possess two
fundamental characteristics: relevance and faithful representation,” (Libby, Libby &
Phillips, 4th ed. 2015). Companies using GAAP must adhere to the ‘matching principle’
or Expense Recognition Principle, in addition to the cost, revenues, and full disclosure
principles.
The matching principle is a fundamental key to GAAP, and understandably so.
Recognizing expenses when the obligations arise together with the related revenues,
yields the most accurate reflection of what actually took place in the given accounting
period. In turn, if companies were to record cash simply when it was paid or received,
“…this could distort a business’s income statement and make it look like they were
doing much better or worse than is actually the case,” (Boundless, 2015).
Indigo’s case deals primarily with the ‘matching principle’ in that choosing
whether or not to record the transaction properly will determine if the expense
recognition principle is satisfied. Recording the transaction with a debit to cash (+A) for
the amount the customer paid, as well as crediting unearned revenue (+L) for the same
amount, ultimately results in an equal increase in both assets and liabilities with
stockholders’ equity unchanging. Therefore, both financial reports, the income
statement and balance sheet for the current and up coming year, will be accurately
reported and equally balanced. On the other hand, if following James’ request, a debit to
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Running head: Case in Technical and Ethical Issues of Accounng
cash (+A) will be recorded along with a debit to sales revenue (+SE), which will
inaccurately offset both the accounting equation and the balance sheet. Using James’
method would make the companies year one revenues and net income on the income
statement overstated, while causing an understatement of year one liabilities and
unearned revenue. Naturally, year two’s revenues and stockholders’ equity would both
be understated due to the improper recording of the revenue.
“Financial statements are the measuring stick that numerous parties use to asses
the financial health of a company,” (Coenen, 2007). On the inside, managers and
owners speculate and determine future actions based upon reports. On the outside,
potential creditors and investors try to determine the company’s worth and ability to
repay liabilities. James’ desired improper recording would alter the perceptions of inside
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