E-Z Loan, Co., makes loans to high-risk borrowers. E-Z borrows from its bank and then lends money to people with bad credit. The bank requires E-Z Loan to submit quarterly financial statements in order to keep its line of credit. E-Z’s main asset is Notes receivable. Therefore, Uncollectible note expense and Allowance for uncollectible notes are important accounts. Slade McMurphy, the owner of E-Z Loan, wants net income to increase in a smooth pattern, rather than increase in some periods and decrease in others. To report smoothly increasing net income, McMurphy underestimates Uncollectible note expense in some periods. In other periods, McMurphy overestimates the expense. He reasons that over time the income overstatements roughly offset the income understatements.
Requirement
1. Is McMurphy’s practice of smoothing income ethical? Why or why not?