Self – Test Questions

Case 1

ABC is a building contractor. After losing a number of big lawsuits, it was facing its first annual net loss
as the end of the year approached. The owner, Addisu, was under intense pressure from the company’s
creditors to report positive net income for the year. However, he knew that the controller, Belete, had
arranged a short-term bank loan of Br 10,000 to cover a temporary shortfall of cash. He told Belete 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.

Requirements
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?

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Case 2
Roy was the accounting manager at Zelalam Company, a tire manufacturer, and he played golf with
Hailu, the CEO, who was something of a celebrity in the community. The CEO stood to earn a
substantial bonus if Zelalam increased net income by year-end. Roy was eager to get into Hugh’s elite
social circle; he boasted to Hugh that he knew some accounting tricks that could increase company
income by simply revising a few journal entries for rental payments on storage units. At the end of the
year, Roy changed the debits from “rent expense” to “prepaid rent” on several entries. Later, Hailu got
his bonus, and the deviations were never discovered.

Requirements

1. How did the change in the journal entries affect the net income of the company at year-end?

2. Who gained and who lost as a result of these actions?

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Case 3

Grant Film Productions wishes to expand and has borrowed Br 100,000. As a condition for making this
loan, the bank requires that the business maintain a current ratio of at least 1.50.
Business has been good but not great. Expansion costs have brought the current ratio down to 1.40 on
December 15. Rita, owner of the business, is considering what might happen if she reports a current
ratio of 1.40 to the bank. One course of action for Grant is to record in December Br 10,000 of revenue
that the business will earn in January of next year. The contract for this job has been signed.

Requirements

1. Journalize the revenue transaction, and indicate how recording this revenue in December would
affect the current ratio.
2. Discuss whether it is ethical to record the revenue transaction in December. Identify the accounting
principle relevant to this situation, and give the reasons underlying your conclusion.

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