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

If owner or the management find that there is a large discrepancy in sales between the current year and past years they are going to ask the company to justify the change. If they decide that ACME to accelerate some sales to improve his financial statement ratios. He has called his best customers and asked them to make their usual January purchases by December 31. This is not the most ethical approach.. Problem is that if it's for a substantial amount of money the loan committee is going to compare Atlantis Company’s financial statements to prior periods. If they notice a large discrepancy in sales between the current year and past years they are going to ask the company to justify the change. If they decide that the customers he would allow them, until the end of February, to pay for the purchases, just as if they had made their purchases in January you will not get the money within slandered time. It depends on how much you are borrowing and how sharp the lenders are at financial analysis. It is probably not worth the risk, because if ACME does get the money. ACME is probably borrowing over it head and over the long run won't be able to cover the debt service.