Question

Chris P. Bacon is the chief accountant for CV Industries, a large manufacturing company. In addition to its normal business activities, the company has excess warehouse space that it rents out to local businesses. Because the typical renter is a small business, CV Industries requires renters to make lease payments for the entire rental period on the day the lease is signed. As a result, CV Industries typically reports a large unearned rent balance on its balance sheet.

After making adjusting entries for the current year, Chris prepares the adjusted trial balance and notices that the company’s earnings will decline significantly. He presents the adjusted trial balance to the company’s CFO, Antonio Beldin, who is concerned about the earnings decline. Mr. Beldin notices the large unearned rent balance and proposes making an additional end-of-period adjusting entry to recognize the entire unearned rent balance as revenue in the current period. Chris protests, reminding Mr. Beldin that the adjusting entry for unearned rent has already been made. Mr. Beldin assures Chris that his proposal is acceptable, reminding Chris that “because we have already received the cash, we have the right to recognize the revenue in the current period.” He instructs Chris to make the additional adjusting journal entry. Chris is hesitant to follow these instructions, but he is sensitive to the company’s emphasis on earnings growth and makes the adjusting entry as instructed.

1. Is Chris behaving ethically? Why?

2. Who is affected by Chris’s decision?

Answer 1

Solution :

Facts of the case :

The company has let out the excess space on rent to a small company, which has paid the entire lease rentals amount on the day of signing the agreement. Following Beldin's order, Chris has proceeded to recognise the entire revenue during the year as cash is received which improved the results of the company.

Analysis :

The conservatism principle states that do not anticipate the profits, and recognize the profits only when it is earned.

The revenue earned by the company should be treated as a "Deferred Revenue". The amount received in advance indicates a liability for the service to be rendered by the company in the upcoming period.  

Therefore, since the service is due from the company in the future, the company should recognize the advance rentals received as a "Liability" in the balance sheet and the revenue should be recognized as and when the service has been provided.

Therefore, Mr. Chris is violating the accounting principles knowing that it is not right to do so.

He recognizes the entire amount as revenue resulting in manipulation of financial statements to reflect a a better position of the company.

This behaviour of Chris is unethical.

The stakeholders of the company are affected by the Chris's decision.

The stakeholders based on the financial statements presented think that the company is performing well. But in reality, the actual performance of the company is poor. Hence, fraudulent concealment and manipulation of results will affect the company's position in the long run which may even lead to insolvency and the closure of the company.