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This post addresses improper revenue recognition issues.

The net income of Steinbach & Sons, a department store, decreased sharply during 2014. Mort Steinbach, manager of the store, anticipates the need for a bank loan in 2015. Late in 2014, Steinbach instructs the store's accountant to record a $2,000 sale of furniture to the Steinbach family, even though the goods will not be shipped from the manufacturer until January 2015. Steinbach also tells the accountant not to make the following December 31, 2014, adjusting entries:

Salaries owed to employees $900
Prepaid insurance that has expired $400

1. Compute the overall effects of these transactions on the store's reported income for 2014.
2. Why is Steinbach taking this action? Is his action ethical? Give your reason, identifying the parties helped and the parties harmed by Steinbach's action. (Challenge)
3. As a personal friend, what advice would you give the accountant? (Challenge)

Solution Preview

1. Compute the overall effects of these transactions on the store's reported income for 2014.

The $2,000 sale that hasn't been earned but is being recorded will increase net income for 2014. The salaries owed to employees will increase salary expense by $900 and will increase insurance expense by $400, both of which will drop net income. By not making the adjusting entries, the owner is keeping net income as high as he can so that he has a better chance of getting the bank loan. This is also the reason why he inflated their annual revenue by $2,000.

2. Why is Steinbach taking ...

Solution Summary

The solution explains why the transactions indicated would be ethically wrong, the effect that the transactions will have on the reported income, and why this action is being taken. Advice is also given as to what you should tell the accountant.

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