Assignment 2: Ethical Issue: Reclassification of Receivables Respond to the foll
ID: 2738789 • Letter: A
Question
Assignment 2: Ethical Issue: Reclassification of Receivables
Respond to the following ethical issue concerning the reclassification of receivables in your initial post:
Moss Exports is having a bad year. Net income is only $60,000. Also, two important overseas customers are falling behind in their payments to Moss, and Moss's accounts receivable are ballooning.
The company desperately needs a loan. The Moss Exports board of directors is considering ways to put the best face on the company's financial statements. Moss's bank closely examines cash flow from operations. Daniel Peavey, Moss's controller, suggests reclassifying as long-term the receivables from the slow-paying clients. He explains to the board that removing the $80,000 rise in accounts receivable from current assets will increase net cash provided by operations. This approach may help Moss get the loan.
1. Using only the amounts given, compute net cash provided by operations, both without and with the reclassification of the receivables. Which reporting makes Moss look better?
2. Under what condition would the reclassification of the receivables be ethical? Unethical? Support your response.
Explanation / Answer
PART 1
The net income for the year is $60,000
In the situation when the receivables are recognized as current assets then the receivables increase by $80,000. This would be equivalent to a cash outflow of $80,000 to compute the operating cash flow.
Operating Cash FLow = Net Income- Change in Receivables = 60000-80000 = -$20000
If the receivables are not classified as current assets then the change in receivables becomes zero and thus
Operating Cash Flow = Net Income- Change in Receivables = 60000-0 = $60,000
The situation when the receivables are not recognized makes the company's financials look much better as the operating cash flow is positive.
PART 2
Reclassification of the receivables will be ethical only if the company does not recognize the receivables as part of the revenue and removing the corresponding expenses incurred as well. This would result in consistency in treatment of the receivables as long term asset. As the receivables are realized going forward the revenue should be recognized.
IF the company recognizes the total revenue from receivables in the income statement but classifies the receivables as long term assets then the recording will be inconsistent and un-ethical. Though the overall cash position will not change but the operating cash flows will look inflated.