ASSIGNMENT: Grant Film Productions wishes to expand and has borrowed $100,000. As a condition for making this loan, the bank requires that the business maintain a current ratio of at least 1.50.
Business has been good but not great. Expansion costs have brought the current ratio down to 1.40 on December 15. Rita Grant, owner of the business, is considering what might happen if she reports a current ratio of 1.40 to the bank. One course of action for Grant is to record in December $10,000 of revenue that the business will earn in January of next year. The contract for this job has been signed.
- Journalize the revenue transaction, and indicate how recording this revenue in December would affect the current ratio.
- Discuss whether it is ethical to record the revenue transaction in December. Identify the accounting principle relevant to this situation, and give the reasons underlying your conclusion.
Instructions: Replies to classmates should be a minimum of 150 words and include direct questions.
As defined in Horngren’s Accounting, the current ratio is a measure of the ability of the company to pay current liabilities from current assets. So, total current assets divided by total current liabilities will give the current ratio. Current, obviously, being the operative word. A high current ratio specifies a company’s ability to pay its current debts, and an increasing ratio is desirable. A strong current ratio would be 1.5, while a ratio closer to 1.0 would be thought as low.
In a situation like the one faced by Grant Film Productions, it may be desirable to record revenue that has not yet been earned in order to keep the $100,000 loan from the bank by maintaining a current ratio of 1.50 or higher.
The journalized entry:
|Date||Accounts and Explanation||Debit||Credit|
|Performed service and received cash|
While recording the unearned revenue for January in December would be tempting, and could potential be a solution to the dilemma faced by Grand Film Productions, it would not be an ethical course of action. According to the revenue recognition principle, the only business recordings of revenue that are allowed are recordings of transactions that have actually been earned. The theory that the revenue will potentially and eventually be earned in the following month is not a good or ethical reason to record the transaction with it having taken place.
Because Grant Film Productions is in such a situation where they are in violation of the terms of the loan, perhaps a good course of action would be to attempt to renegotiate the terms of the loan with the bank. That way the company can potentially keep the loan amount without violating any accounting principles.
Nobles, T., Mattison, B., & Matsumura, E. M. (2014). Horngren’s Accounting, 10th Edition. Pearson Education, Inc.
STUDENT 2 (Karen):
Accounts and Explanation
Performed service and received cash payment
With Grant Film Productions, it would be a benefit to record the revenue not yet earned to keep the bank from rejecting the $10,000 loan. By recording, this early Grant Film Productions could maintain current ration. However, recording this would not be ethical; a signed contract is not the same as actually providing the service. I personally would not even consider this as an ethical dilemma. I would just follow the regulations put in place and abide. Grant Film Productions could easily shop around for a different bank that could work with their actual current ratio, or request that their current bank review the terms of their loan and work with them. “The revenue recognition principle requires companies to record revenue when it has been earned and determines the amount of revenue to record.”(Nobles, Mattison, & Matsumura, 2014). With that being said, the revenue has not yet been earned, as the service has not been provided. A similar business that would face this type of issue would be a limousine company; they are booked for weddings and have signed contracts and often the funds paying for the service. The service has not yet been provided. I would think that if this was recorded as revenue when it wasn’t, accounting would be complicated for services that are cancelled. Many interesting points in this weeks readings. It is certainly news to me that there are so many ethical dilemmas in accounting, but that is probably why accountants show up on the news often. The lure of money….
Nobles, T., Mattison, B., & Matsumura, E. M. (2014). Horngren’s accounting (10th ed.). Upper Saddle River, NJ: Pearson.