Suppose you work in the loan department of Superior Bank. Dean Young, owner of Dean Young Beauty Aids, has come to you seeking a loan for $500,000 to expand operations. Young proposes to use accounts receivable as collateral for the loan and has provided you with the following information from the company’s most recent financial statements:
20X7
20X6
20X5
(In thousands)
Sales
$1,475
$1,001
$902
Cost of goods sold
876
647
605
Gross profit
$ 81
$ 67
$ 44
Other expenses
$ 128
$ 107
$ 94
Net profit or (loss) before taxes
13
11
9
Accounts receivable
599
354
297
Allowance for doubtful accounts
518
287
253
Required
Analyze the trends of sales, days’ sales in receivables, and cash collections from customers for 20X7 and 20X6. Would you make the loan to Young? Support you decision with facts and figures. Sunnyvale Loan Company is in the consumer loan business. Sunnyvale borrows from banks and loans out the money at higher interest rates. Sunnyvale’s bank requires Sunnyvale to submit quarterly financial statements to keep its line of credit. Sunnyvale’s main asset is Notes Receivable. Therefore, Uncollectible-Account Expense and Allowance for Uncollectible Accounts are important accounts for the company. Kimberly Burnham, the company’s owner, prefers for net income to increase in smooth pattern, rather than increase in some periods and decrease in other periods. To report smoothly increasing net income, Burnham underestimates Uncollectible-Account Expense in some periods. In other periods, Burnham overestimates the expense. She reasons that the income overstatements roughly offset the income understatements over time.
Is Sunnyvale Loans’ practice of smoothing income ethical? Why or why not?