Question

Question 2                                                                                                                  [15 marks]

Phoenix Photography Company experienced a sharp decrease in Net Income during the year 2016. Madea Perry, the owner of the company, anticipates a need for a Bank loan in the year 2017. Late in 2016, Perry instructed Reunion Mann, the accountant, and friend of his to record a R10, 000 sale of portraits to the Perry family even though the photos will not be shot until January 2017. Perry told Reunion not to make the following December 31 2016 adjusting entries

Salaries owed to employees R 20000

Prepaid insurance that has expired 2000

Required:

1. Compute the overall effect of these transactions on the company’s reported income for 2016. Is the reported net income overstated or understated.

2. Why did Madea take these actions? Are they ethical? Give your reason, identifying the parties that benefitted and those that were harmed by Madea’s actions.

Use the ethical decision making model which factor (economic, legal or ethical) seems to be taking precedence? Identify the stakeholders and potential consequences to each.

3) As a personal friend of Perry’s, what advice would you give to him?

Answer 1

1. Madea has instructed hia accountant to do 2 things. (1) to recognise revenue which not yet earned and (2) Not to write off expenses which should be written off.

This means the Income of the company is overstated by 10000 and the expenses of the company are understated by 22000. The overall effect is thet the net income of the company before taxes is overstated by 32000.

2. The revenue of the company has decreased in Nov 2017. The company needs a loan from the Bank. For a Bank to approve the loan the Bank will examine the statements of Phoenix photographic company and it will one of imortant points on the basis of which the bank loan will be approved. Madea has told his accountants to book income in advance and to delay the expenses so that the financila statements will give a better lookng picture to the bank and increase the chances of approval of the loan.

The actions of Madea are not ethical. There are legal and ethical factors whic tak precedence here. The stakeholders here are the bank, the creditors of the company and the investors. There is misrepresetation of facts in the financial statement which will mislead the bank and the investors of the company as to the standing of the company as on December 31. The Bank may aprove the loan based on the financial statements which the company may not be able to repay causing a loss to the bank. The investors would be misleaded to believe that the companys return is higher as the net income of the company is overstated.

3. As Perry's friend, I would advise him not to misrepresent the facts in the books of accounts. If the compan is not able to pay the loan in future not only will the credit rating of the company will be affected, investors might lose confidence in the company. In addition to that, there would be legal consequence for Perry and the accountant who would help him misrepresent facts.