Response to the following problem:
Fraud Case Exeter, Inc., is a building contractor on the Gulf Coast. After losing a number of big lawsuits, it was facing its first annual net loss at the end of the year approached. The CEO, Hank Snow, was under intense pressure from the major shareholders to report positive net income for the year. However, he new that the controller, Alice Li, Had, arranged a short-term bank loan of $10,000 to cover a temporary shortfall crash. He told Alice 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.
1. How would this action affect the year-end income statement? How would it affect the year-end balance sheet?
2. If you were a major shareholder who wanted to sell a block of shares to other investors, how would this fraudulent action affect you?
Req. 1 The proposed action would increase net income by increasing revenues. It would distort the balance sheet by understating liabilities.
Req. 2 By making the companys financial situation look better than it actually was, the stock prices would likely be higher, and a person selling stock would likely receive more for it.