Chapter 2
Linking Personal Accounting to Business Accounting
51
Ethics
Owners and managers of businesses have control over how revenue and expenses are recorded and
reported on the income statement. Perhaps the most famous example of misrepresenting revenue comes
from Enron, a large energy company in the United States. Over a period of five years, Enron reported
an increase in revenue of more than 750%.This massive increase in revenue was partly due to counting
the full amount of trading contracts, instead of just brokerage fees, as revenue.
Another example of corporate fraud was committed by WorldCom, a telecommunication company. In
addition to misrepresenting revenue, it also took certain expenses and recorded them as assets on the
balance sheet. Thus, by increasing revenue and eliminating certain expenses, WorldCom was able to
show very large profits. In both the Enron and WorldCom cases, executives were charged and went to
jail for their involvement in fraud.
On a smaller business level, the owner of a banquet hall may receive deposits from customers to book
the hall months in advance. As we learned, customer deposits must be treated as a liability (unearned
revenue) until the service is actually performed.
Suppose the owner requires additional financing from the bank to help pay for an expansion to the
hall and feels her income may not be enough to get the loan. To make her net income appear higher,
the owner may decide to record the customer deposits as revenue instead of a liability. By inflating her
revenue and profits, she hopes the bank will grant her the loan she needs.This action is unethical.
Consider a sole proprietor who is attempting to minimize the amount of taxes he must pay to the
government on his business income. If he has a significant amount of prepaid expenses recorded as
assets, he may be tempted to report them all as expenses. He may also be tempted to overstate the
expenses by including personal expenses in his business records. All these would reduce the net income
and the amount of taxes to be paid. Including personal expenses in business records is illegal, and can
lead to charges and penalties imposed by the government.
