Fraud case - Arthur Chen, a newly qualified accountant, was on his second audit job in a country area with a new client called Parson Farm Products. He was looking through the last four years of financials and doing a few ratios, when he noticed something odd. The current ratio went from 1.9 in 2009 down to 0.3 in 2010, despite the fact that 2010 had record income. He decided to sample a few transactions from December 2010. He found that many of Parson's customers had returned products to the firm because of substandard quality. Chen discovered that the business was clearing the receivables (that is, crediting accounts receivable) but hiding the debits in an obscure non-current asset account called ‘grain reserves' to keep the firm's income ‘in the black' (that is, positive income).

Requirements

1. How did the fraudulent accounting just described affect the current ratio? (Hint: Think about Cash.)

2. Can you think of any reasons why someone in the firm would want to take this kind of action?