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Analyze a scenario where the CEO of Reliable Inc., Mr. Fraud, instructs the company's controller, Mr. Ethics, to manipulate financial statements in order to conceal ongoing financial losses. The actions include overstating land value, reversing bad debts without proper basis, and reclassifying unearned revenue as earned revenue. As a CPA and a friend of Mr. Ethics, discuss the fundamental ethical issues involved, identify the GAAP principles violated by each suggested action, and provide advice on ethical decision-making and proper accounting practices.

Paper For Above instruction

The scenario involving Mr. Fraud and Mr. Ethics at Reliable Inc. presents a clear violation of fundamental accounting ethics and principles. At its core, the ethical issue revolves around the intentional misrepresentation of financial information to hide poor financial performance and to potentially secure favorable financing. Such actions breach the core values of integrity, objectivity, and professional competence that underpin the accounting profession.

The first questionable action involves overstate the value of land from the appraised $30,000 (or the more conservative estimated fair value of $50,000) without proper valuation procedures. Under Generally Accepted Accounting Principles (GAAP), land should be recorded at historical cost, which is the actual purchase price, and subsequent revaluation is generally not permitted, except in specific cases such as certain accounting frameworks like IFRS, not GAAP. This manipulation violates the principle of faithful representation and consistency. Inflating land assets to improve the balance sheet misleads stakeholders and violates the Fundamental Conservatism principle that encourages cautious and prudent reporting.

Secondly, reversing or reclassifying bad debts from a customer, Mr. Bankrupt, without evidence or proper justification, undermines the accuracy of accounts receivable. GAAP requires that bad debts be recognized based on receivables' recoverability and proper accounting for impairments, not arbitrary reversal to inflate income. By ignoring the actual financial condition of Mr. Bankrupt's company, this action breaches the revenue recognition principle and fair presentation, leading to distorted profitability figures and misleading financial statements.

The third action involves reclassifying unearned revenue—liabilities received before services are performed—as service revenue. GAAP clearly states that revenue should only be recognized when earned, and all relevant criteria (such as delivery of goods or services and transfer of risks and rewards) are met. Recognizing unearned revenue prematurely violates the revenue recognition principle, resulting in an overstatement of sales and net income. This practice compromises the credibility of the financial statements and violates the principles of faithful representation and integrity.

As a CPA and a friend, my advice to Mr. Ethics is to adhere strictly to ethical standards and GAAP principles. Integrity and objectivity should guide his actions, and he should refuse to participate in fraudulent reporting. Instead, he should document the pressure from Mr. Fraud and recommend to executive management the importance of accurate and honest financial reporting. If necessary, he should escalate the concerns to the audit committee or regulatory bodies. Maintaining professional ethics is essential to uphold the credibility of the financial reporting process, protect stakeholders' interests, and avoid legal repercussions associated with fraudulent accounting practices.

References

• American Institute of Certified Public Accountants (AICPA). (2022). Code of Professional Conduct. AICPA.
• Financial Accounting Standards Board (FASB). (2023). Accounting Standards Codification (ASC).
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