Question

WestWorld Robotics wishes to expand their business operations and has borrowed $250,000 from a regional bank where they manufacture state-of-the-art robotic limbs. As a condition for the loan, Midland Bank is requiring that WestWorld maintain a current ratio of a minimum 1.5:1.

Orders for the company's products have been very good, however, not what was expected during financial planning for the year. The costs to expand the business have resulted in a current ration of 1.4:1 on December 10. Jayson Hopwood, CEO and sole shareholder of the business, is wondering what the effects might be if he reports a current ratio of 1.4:1 to Midland Bank.

One option for Hopwood is to record and report a large sale of the company's products in December that will actually not occur until a few days after the new accounting period begins on January 1. The contract has been signed for the sale, but no monies or products have changed hands.

Please:

Prepare a journal entry to record the transaction as of December 10, assuming the amount is $75,000. Also, indicate how recording this transaction in December could affect the company's current ratio.

Discuss if it is ethical to record and report this sale transaction in December, highlighting any accounting principle relevant to this situation.

Answer 1

Actual Entry for Dec 10 should be as follows :-

Account Receivable A/c Dr. 75,000

To Sales A/c. 75,000.

This cannot be recorded as sales as no money or product have been exchanged

Current Ratio of Company after borrowings = 1.4:1 (Current Assets/Current Liabilites)

Therefore Assuming the only liability is of Loan - 250,000. Current ASsets = 250,000 * 1.4 = 350,000

With Inclusion of the Account Receivable of 75,000 Current Assets = 350,000+75000 = 425,000

New current Ratio = 425,000/25000 = 1.7:1 which satisfies the condition for the loan.

It is not ethical as per GAAP to record the revenue.

revenue from the sale of goods or products should not be recognized until it is earned and realized, or realizable. Revenue is generally earned and realized, or realizable, when all of the following conditions have been satisfied:

• There is persuasive evidence of an arrangement.
• Delivery has occurred (e.g., an exchange has taken place).
• The sales price is fixed or determinable.
• Collectibility is reasonably assured

Since the delivery has not taken place it should not be recorded as Sales.