The accounting records of Ortiz Manufacturing Company (OMC) revealed that the company incurred $3 million of materials, $5 million of production labor, $4 million of manufacturing overhead, and $6 million of selling, general, and administrative expense during 2014. It was discovered that OMC’s chief financial officer (CFO) included $1.5 million dollars of upstream research and development expense in the manufacturing overhead account when it should have been classified as selling, general, and administrative expense. OMC made 5,000 units of product and sold 4,000 units of product in 2014.
a. Indicate whether the elements on the 2014 financial statements (i.e., assets, liabilities, equity, revenue, expense, and net income) would be overstated or understated as a result of the misclassification of the upstream research and development expense. Determine the amount of the overstatement or understatement for each element.
b. Speculate as to what would cause the CFO to intentionally misclassify the research and development expense. (Hint: Review the chapter material regarding the fraud triangle.)