General > The net income of Simon and Hobbs, a department store, ... >

The net income of Simon and Hobbs, a department store, decreased sharply during 2000. Carol Simon, owner of the store, anticipates the need for a bank loan in 2001. Late in 2000, Simon instructs the store's accountant to record a $10,000 sale of furniture to the Simon family, even though the goods will not be shipped from the manufacturer until January 2001. Simon also tells the accountant not to make the following December 31, 2000 adjusting entries:

Salaries owed to employees: $900
Prepaid insurance that has expired: $400
Why is Simon taking this action? Is her action ethical? Give your reason, identifying the parties helped and the parties harmed by Simon's action.

Customer (name blocked for privacy)

Hi, and thanks for giving me the opportunity to answer your question.

Carol is indeed being unethical, attempting to 'cook the books' so that her sales and assets appear to be higher than they actually are, and her liabilities appear lower than they actually are. This is no doubt being done to 'fool' the bank that will be looking at her most recent financial information in order to evaluate her business for a loan.

Specifically:

It seems doubtful that the sale of furniture to the Simon family is legitimate at all. I suspect that the order will be cancelled as soon as the bank loan is approved. In any case, if no money has been paid by the Simon family to the Simon and Hobbs business, and the furniture will not be delivered until 2001, then a sale cannot reasonably be recorded in 2000. This artificially inflates sales, and is illegal, as it violates accounting principals, not to mention unethical.

By not recording wages owed to employees, Simon is artificially REDUCING legitimate liabilities, therefore making the company look stronger on a balance sheet. This is again being done to attempt to impress the bank. It is clearly illegal and unethical.

Prepaid insurance is carried on the balance sheet as an asset. Therefore, when that asset no longer exists, it must be taken off the balance sheet with a reversing entry. By not doing so, Simon is artificially INCREASING assets, therefore making the company look stronger on a balance sheet. Again, it is illegal, and unethical.

In the end, no one is helped by these phoney accounting practices. That was clearly shown in the Enron and Tyco scandals! However, in the short-run the Simon family will probably benefit by receiving a loan from the bank at a more favorable interest rate. It harms the bank, as they are being deceived into believing that the company is financially stronger than it really is. It also will eventually harm the employees and customers, should the Company become insolvent.

I hope that this has answered your question.

Good luck, and best regards.

Michael

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