Question

Atlantis Company sells computer components and plans on borrowing some money to expand. After reading a lot about earnings management, Andy, the owner of Atlantis, has decided he should try to accelerate some sales to improve his financial statement ratios. He has called his best customer and asked them to make their usual January purchases by December 31. Andy told the customers he would allow them, until the end of February, to pay for the purchases, just as if they had made their purchase in January.

1. Is Andy's action complying with GAAP? Why or why not? (i.e. what is the revenue recognition principle?)

2. What do you think are the ethical implications of Andy's action?

3. Which ratios will be improved by accelerating these sales?

Answer 1

1. Andy's Actions are complying with GAAP. Revenue Recognition determines that the specific conditions in which revenue is recognized or accounted for. Generally, Revenue is recognized only when a critical event has occured and the amount of revenue is measurable.

The Revenue recognition principle, is a combination of accrual accounting and matching principle stipulates that revnues are recognized when realized and earned and not necessarily when recived. Realizable means that goods or services have been recieved but payment for that product or service is expected later. Lastly According to the matching principle , the revenue and its associated costs must be reported in the same accounting period. Usually the accounting periods is from 1st April to 31st March, if it differs in this case to 1st January to 31st december then the actions will change to comply to the Accounting standards.

2.As the product is being sold to his customer in the month of January every year there is not ethical implications. But is the Accounting year was from 1st January to 31st decemeber which means that there would be increase in sales in the past year which would give a wrong impact on the other customers.

3.Inventory turnover ratio , Current Ratio , Asset Turnover ratio. In this case with no detailed information We can say that any ratio whose numberator is Sales all those ratios will improve.Where as ,Working Capital Funding Gap would be affected negatively as Andy is increasing its account recievable time period which is not a good sign for any business.