What is the Fundamental Ethical Issue in This Situation?

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How would it affect the year-end balance sheet?

 

SKU: ACC000591

Ethical Behavior

The board of directors of Xiaoping Trading Company is meeting to discuss the past year’s results before releasing financial statements to the bank.  The discussion includes this exchange:

Wai Lee, company owner:  “This has not been a good year!  Revenue is down and expenses are way up.  If we are not careful, we will report a loss for the third year in a row.  I can temporarily transfer some land that I own into the company’s name, and that will beef up our balance sheet.  Brent, can you shave $500,000 from expenses?  Then we can probably get the bank loan that we need.”

Brent Ray, company chief accountant:  “Wai Lee, you are asking too much.  Generally accepted accounting principles are designed to keep this sort of thing from happening.”

1.What is the fundamental ethical issue in this situation?

2.How do the two suggestions of the company owner differ?

 

Fraud

Exeter is a building contractor on the Gulf Coast.  After losing a number of big lawsuits, it was facing its first annual net loss as the end of the year approached.  The owner, Hank Snow, was under intense pressure from the company’s creditors to report positive net income for the year.  However, he knew that the controller, Alice Li, had arranged a short-term bank loan of $10,000 to cover a temporary shortfall of cash.  He told Alice to record the incoming cash as “construction revenue” instead of a loan.  That would nudge the company’s income into positive territory for the year, and then, he said, the entry could be corrected in January when the loan was repaid.

1.How would this action affect the year-end income statement?  How would it affect the year-end balance sheet?

2.If you were one of the company’s creditors, how would this fraudulent action affect you?

 

Accounting Devices

In this chapter, you learned how accountants use accounts, journals, and ledgers. Why do you think that these devices have evolved and why do accountants continue to use them?

 

Trail Balance

Accountants routinely prepare trial balances. What is a trial balance used for? What kinds of accounting errors do you think cannot be detected by a trial balance?

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