Application of accounting principles

You are engaged in the annual audit of the financial statements of Maulack Corp., a medium-sized wholesale company that manufactures light fixtures. The company has 25 shareholders. During your review of the minutes, you observe that the president’s salary has been increased substantially over the preceding year by the action of the board of directors. His present salary is much greater than salaries paid to presidents of companies of comparable size and is clearly excessive. You determine that the method of computing the president’s salary was changed for the year under audit. In previous years, the president’s salary was consistently based on sales. In the latest year, however, his salary was based on net income before income taxes. Maulack Corp. is in a cyclical industry and would have had an extremely profitable year, except that the increase in the president’s salary siphoned off much of the income that would have accrued to the shareholders. The president is a minority shareholder of the company.

REQUIRED

a. What is the implication of this condition for the fair presentation of the financial statements?

b. Discuss your responsibility for disclosing this situation.

c. Discuss the effect, if any, that the situation has on:

1. The fairness of the presentation of the financial statements.

2. The consistency of the application of accounting principles.

Solution: