High school students know how important it is to perform well on the educational tests required by many colleges and universities as part of the admissions process. In fact, an entire industry has developed to prepare students to take these tests. One company in this industry was College Bound Inc. It was a fast-growing company that claimed to be the largest educational counseling firm in the United States with 150 test centers nationally. College Bound was founded by George and Janet Ronkin because they could not find a facility that, in their opinion, could adequately prepare their own son to take the college entrance exams. The company went public in 1988 as a penny stock, and the price of the stock soared to a high of $24 per share in August 1991. In the early months of 1992, however, the SEC began to question many of College Bound’s accounting practices. As a result of its investigations, the SEC determined that much of the rapid growth in revenues reported by College Bound came as a result of “churning bank accounts.” This practice involved transferring funds from the home office’s bank account to various test centers and then back to the home office. College Bound was recognizing as revenue the funds being transferred back from the test centers. The money used for the “churning” was obtained via a convertible note offering in Europe.
The result of these practices was to overstate pretax profits for the fiscal year ended August 1991 by 2.5 times, or $5.2 million. The SEC alleged that the Ronkins were transferring large amounts of company money to their personal accounts. In addition to their compensation of $153,846 each, the Ronkins were said to have transferred over $500,000 to Swiss bank accounts during 1991. The court-appointed receiver, Joseph Del Raso, who was asked by the courts to monitor College Bound during bankruptcy proceedings, determined that most of the company’s 150 test centers were not profitable by industry standards and closed over 100 centers in May 1992.
1. How would College Bound recognize revenue by simply transferring money from a test center to the home office? What would the journal entry be when the money was transferred from the test centers to the home office?
2. How would the accountant at the home office determine if money being received from a test center was to be recorded as revenue or as repayment of a loan?