Question

You have recently been hired as the assistant controller for Stanton Temperton Corporation, which rents building space in major metropolitan areas. Customers are required to pay six months of rent in advance. At the end of 2018, the company's president, Jim Temperton, notices that net income has fallen compared to last year. In 2017, the company reported before-tax profit of $330,000, but in 2018 the before-tax profit is only $280,000. This concerns Jim for two reasons. First, his year-end bonus is tied directly to before-tax profits. Second, shareholders may see a decline in profitability as a weakness in the company and begin to sell their stock. With the sell-off of stock, Jim's personal investment in the company's stock, as well as his company-operated retirement plan, will be in jeopardy of severe losses. After close inspection of the financial statements, Jim notices that the balance of the Deferred Revenue account is $120,000. This amount represents payments in advance from long-term customers ($80,000) and from relatively new customers ($40,000). Jim comes to you, the company's accountant, and suggests that the firm should recognize as revenue in 2018 the $80,000 received in advance from long-term customers. He offers the following explanation: “First, we have received these customers' cash by the end of 2018, so there is no question about their ability to pay. Second, we have a long-term history of fulfilling our obligation to these customers. We have always stood by our commitments to our customers and we always will. We earned that money when we got them to sign the six-month contract.” Required: Discuss the ethical dilemma you face. What is the issue? Who are the parties affected? What factors should you consider in making your decision? Your answer must specifically state what principle or concept may be violated.

Answer 1

The suggestion made by the president is not in accordance with GAAP Rules. It is Against the principle of Revenue Recognition.

As per principle of Revenue Recognition, a revenue is recongnised when goods or services are rendered to its customers. In this given situation, obligation to customers not fulfilled. Payment are received in advance. So, it can't be recongsied as Revenue in 2018.

If Jim's suggesion is follwed, it will affect revenue account and unearned income account. Income Statement Profit will increase which may result high bouns to Jim but unreasoable, extra bonus expense to the company. It also effect Comany's Financial position statement where current liabilty will reflect lower amount and won't stand on principle of 'True n Fair View'.

An accountant shouldn't accept this suggesion. It is agains GAAP rules, Violates Revenue Recognition principle as well as 'True n Fair View' of Financial statements which may harm the share holders as well as the company itself.