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Annette Kagel opened Harre Real Estate Co. on January 1, 2007. At the end of the first year, the business needed additional capital. On behalf of Harre Real Estate, Annette applied to Lake County State Bank for a loan of $200,000. Based on Harre Real Estate’s financial statements, which had been prepared on a cash basis, the Lake County State Bank loan officer rejected the loan as too risky.

After receiving the rejection notice, Annette instructed her accountant to prepare the financial statements on an accrual basis. These statements included $31,500 in accounts receivable and $10,200 in accounts payable. Annette then instructed her accountant to record an additional $10,000 of accounts receivable for commissions on property for which a contract had been signed on December 28, 2007, but which would not be formally “closed” and the title transferred until January 5, 2008.

Annette then applied for a $200,000 loan from First National Bank, using the revised financial statements. On this application, Annette indicated that she had not previously been rejected for credit.

Do you feel that Annette is acting ethically? As the accountant in this situation, how do you explain the discrepancy in the numbers? How would you explain the differences between cash basis and accrual basis? Is it possible to have a net income in one situation and a net loss in another situation? How would you have handled this situation differently?

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