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

Answer 1. The net income reported in 2016 is overstated 32,000

-- Sales Revenue overbooked of 10000

--Non booking of salary and insurance expenses of 22000

Answer 2. Madea took these actions to inflate his profits. These actions and unethical.

Due to these actions the company is benefitted as its credibility has increased because of higher profits, the stakeholders are not harmed as such but these entries represent incorrect presentation of income.

Economic factor seems to be taking precedence in this case.

Stakeholders and potential Consequences:-

Shareholders- They will receive higher return to their investment.

Finances/Bank- Inflated credibility may put their finances in risk.

Debtors- Higher amount of debtors will be visible in accounts for the year end hence an increase in Receivables.

Answer 3. As a personal friend, I would avoid making such adjustments as it creates a risk of legal litigations. Also I would help him to analyse other finance options and help him conduct business ethically.

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