Question

Exeter is a building contractor on the Gulf Coast. After losing a number of big lawsuits, it was facing its first annual net loss as the end of the year approached. The owner, Hank Snow, was under intense pressure from the company’s creditors to report positive net income for the year. However, he knew that the controller, Alice Li, had arranged a short-term bank loan of $10,000 to cover a temporary shortfall of cash. He told Li to record the incoming cash as “construction revenue” instead of a loan. That would nudge the company’s income into positive territory for the year, and then, he said, the entry could be corrected in January when the loan was repaid. Requirements 1. How would this action affect the year-end income statement? How would it affect the year-end balance sheet? 2. If you were one of the company’s creditors, how would this fraudulent action affect you?

Short answer

Creditor will be harmed due to misrepresentation as reporting revenues instead of liabilities, may encourage creditor to lend money or provide credit.

Step-by-step solution

Step-by-Step SolutionStep 1: Explanation on Creditors

Creditors are the lending institution or supplier that lends funds or provides credit to the entity.

Effect on creditors

Reporting loan as revenue is a part of misrepresentation in the financial statement. It may hamper the decision of the creditor to provide credit to the company. Reporting it as revenues, may motivate the creditor to provide creditor, without knowing the fact of this error.