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 Accounts Receivable. Therefore, Bad Debts Expense and Allowance for Bad Debts 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 Bad Debts Expense in some periods. In other periods, McMurphy overestimates the expense. He reasons that over time the income overstatements roughly offset the income understatements.

Requirements: (Part A: 50 points maximum; part B: 50 points maximum)

A. 1. Critically analyze the relevant factors in this case.

2. Include in your analysis

• who, other than O’Conner, could be harmed by this theft and in what ways could they be harmed; and
• the role accounting plays in this situation.