Chapter 5
The Accounting Cycle: Adjustments
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Ethics
It is possible to intentionally manipulate adjustments to change how the financial performance
and position of the company is presented. If the manipulation hides information from users, this is
unethical. Consider the accrual of interest on a bank loan. Management should not wait until the
interest is paid to record interest. Interest should be accrued at the end of an accounting period and
thus reflected as interest expense on the income statement. If management fails to accrue interest
at the end of an accounting period, the financial statements will understate liabilities (since interest
payable is understated) and overstate net income (since interest expense is understated). This will
provide investors and creditors an incorrect representation of the company’s performance and debt
position.
As an internal control, management should review the terms of the debt contracts for all
outstanding long-term liabilities at the end of an accounting period.This will provide management
with a reasonable idea of what the interest expense should be for the period after including accrued
interest as well.
