Arthur Chen, a newly minted CPA, was on his second audit job in the Midwest with

Question

Arthur Chen, a newly minted CPA, was on his second audit job in the Midwest with a new client called Parson Farm Products. He was looking through the past four years of financials & doing a few ratios when he noticed something odd. The current ratio went from 1.9 in 2011 down to 0.3 in 2012, despite the fact that 2012 had record income. He decided to sample a few transactions from Dec 2012. He found that many of Parson's customers had returned products to the company because of substandard quality. Chen discovered that the company clearing the receivables (i.e. crediting account receivable) but "stashing" the debits in an obscure long-term asset account called "grain reserves" to keep the company's income "in the black" (i.e. positive income).

1. How did the fraudulent accounting just described affect the current ratio?

2. Can you think of any reasons why someone in the company would want to take this kind of action?

Explanation / Answer

1) Current ratio = current assets/ current liabilties

since they are reducing the account recievables this will decrease the current assets , so the ratio will decrease but even if their is no fraud accounting the current ratio will be decreased since they are correctly crediting the account receivable account.

2)probably their commissions is based on net income hence they are trying to show postive income

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