Question

Ruth Harbin opened Macaw Real Estate Co. on January 1, 2005. At the end of the...

Ruth Harbin opened Macaw Real Estate Co. on January 1, 2005. At the end of the first year, the business needed additional capital. On behalf of Macaw Real Estate, Ruth applied to First City Bank for a loan of $120,000. Based on Macaw Real Estate's financial statements, which had been prepared on a cash basis, the First City Bank loan officer rejected the loan as too risky. After receiving the rejection notice, Ruth instructed her accountant to prepare the financial statements on an accrual basis. These statements included $41,500 in accounts receivable and $13,200 in accounts payable. Ruth then instructed her accountant to record an additional $12,500 of accounts receivable for commissions on property for which a contract had been signed on December 28, 2005, but which would not be formally "closed" and the title transferred until January 20, 2006. Ruth then applied for a $120,000 loan from Second National Bank, using the revised financial statements. On this application, Ruth indicated that she had not previously been rejected for credit. what  ethical and professional conduct did Ruth Harbin commit in applying for the loan from Second National Bank?

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It is acceptable for Ruth to prepare the financial statements for Macaw Real Estate on an accrual basis. The revision of the financial statements to include the accrual of the $12,500 commissions as of December 31, 2005, is proper if there remain no contingencies related to the signed, unconditional contract of sale. That is, if the closing and title transfer is not contingent upon an appraisal, obtaining a loan, etc., then the earnings process has been completed from the perspective of Macaw Real Estate and the commissions have been earned. If contingencies remain, then the commission should not be accrued as of December 31, 2005. Indicating on the loan application to Second National Bank that Macaw Real Estate has not been rejected previously for credit is unethical and unprofessional. In addition, intentionally filing false loan documents is illegal.

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