Question

Daryl Kirby opened Squid Realty Co. on January 1, 20x3. At the end of the first year, the business needed additional capital. On behalf of Squid Realty Co., Daryl applied to Ocean National Bank for a loan of $375,000. Based on Squid Realty Co.’s financial statements, which had been prepared on a cash basis, the Ocean National Bank loan officer rejected the loan as too risky.

After receiving the rejection notice, Daryl instructed his accountant to prepare the financial statements on an accrual basis. These statements included $65,000 in accounts receivable and $25,000 in accounts payable. Daryl then instructed his accountant to record an additional $30,000 of accounts receivable for commissions on the property for which a contract had been signed on December 28, 20x3. The title to the property is to transfer on January 5, 20x4, when an attorney formally records the transfer of the property to the buyer.

Daryl then applied for a $375,000 loan from Free Spirit Bank, using the revised financial statements. On this application, Daryl indicated that he had not previously been rejected for credit.

Describe the various ethical and professional issues involved in this case.

Ethical or Unethical?

Describe whether you believe each of the parties you listed above acted ethically or unethically in relation to all of the ethical issues you listed. Support your position with a rational moral and/or professional argument.

Answer 1

In the given question, on behalf of Squid Realty Co., Daryl applied to Ocean National Bank for a loan of $375000. Based on the company's financial statement which had been prepared on a cash basis, the Ocean National Bank loan officer rejected the loan application as too risky.

As per Generally Accepted Accounting Principle (GAAP), Accounting can be done on either cash basis or accrual basis. The difference between two relates to when revenue and expenses are recognized in the books. Cash basis accounting recognizes money as it comes in or goes out. This method keeps the book up to date and gives the owner a real tine view of the business finances. One of the major limitations, however is that it does not account for the receivables and therefore does not always show the big picture of a company's finances. While Accrual method books the earned revenue or expenses when they are incurred and not when they are received. Accrual accounting gives a holistic perspective of the business and a good view of the overall health of the company.

In the given case, After receiving the rejection notice, Daryl instructed his accountant to prepare the financial statement on Accrual basis. This is ethical as banks prefer the financial statement of the company to be prepared on accrual basis as it allows the lenders to have a good view of the overall health of the company. It allows the lenders to determine if the finances are healthy and the income is sufficient to service the debt the company has and for which it is applying. So, revising the financial statements as per Accrual method for the purpose of loan application is ethical.

Also, Daryl then instructed his accountant to record an additional $30,000 of accounts receivable for commissions on the property for which a contract had been signed on December 28, 20x3 but the title to the property is to transfer on January 5, 20x4 when an attorney formally records the transfer of the property to the buyer. It is an Adjusting Event as there is a condition that existed at the balance sheet date. Therefore, accounts receivable shown by the company is ethical.

However, in the given case, Daryl indicated on the application that he had not previously been rejected for credit. It is not ethical as he is misleading the bank since the loan application was rejected by the previous bank.Therefore, the act of Daryl is not ethical.