Topic 1:Understanding Application of Accrual Accounting Method

Cliff Hall opened Meridian Co. on January 1, 2009. At the end of the first year, the business needed additional capital. On behalf of Meridian, Cliff applied to Federal National Bank for a loan of $300,000. Based on Meridian's financial statements, which had been prepared on a cash basis, the Federal National Bank loan officer rejected the loan as too risky. After receiving the rejection notice, Cliff instructed his accountant to prepare the financial statements on the accrual basis of accounting. When the financial statements are prepared on the accrual basis of accounting, they included $48,500 in accounts receivable and $15,650 in accounts payable.

Cliff then instructed his accountant to record an additional $20,000 of accounts receivable for merchandise ordered by a customer that will not be delivered until January 5, 2010. Cliff then took the revised financial statements to a different bank, First City Bank, and applied for a $300,000 loan. On this application, Cliff indicated that he had not previously been rejected for credit. Please review the information on pages 3-3 and 3-4 in your textbook and then answer the questions.

• Were the revisions to the financial statements correct or incorrect? Why or why not? Be sure to use detailed reasons to support your response.
• Was the inclusion of the $20,000 of in accounts receivable correct or incorrect? Why or why not? Be sure to use detailed reasons to support your response.
• Discuss the ethical and professional conduct of Cliff Hall in applying for the loan at the second bank, First City Bank.