PROBLEM 24-1

SABRINA CORPORATION

Balance Sheet

As of December 31, 2005

 

Assets

Current assets

        Cash ($571,000 – $400,000)                                                                $   171,000

        Accounts receivable

             ($480,000 + $30,000)                                     $   510,000

                Less allowance for

                    doubtful accounts                                        30,000                     480,000

        Notes receivable                                                                                     162,300

        Inventories (LIFO)                                                                                   645,100

        Prepaid expenses                                                                                      47,400

                        Total current assets                                                                                           $1,505,800

Long-term investments

        Investments in land                                                                                 185,000

        Cash surrender value of

            life insurance                                                                                          84,000

        Cash restricted for plant

            expansion                                                                                             400,000                   669,000

Property, plant, and equipment

        Plant and equipment

            (pledged as collateral

             for bonds)

            ($4,130,000 + $1,430,000)                                5,560,000

                Less accumulated

                    depreciation                                            1,430,000                  4,130,000

        Land                                                                                                           446,200                4,576,200

Intangible assets

        Goodwill, at cost                                                                                                                      252,000

                        Total assets                                                                                                         $7,003,000

                                     Liabilities and Stockholders’ Equity

Current liabilities

        Accounts payable                                                                               $   510,000

        Estimated income taxes

           payable                                                                                                   145,000

        Dividends payable                                                                                   200,000

        Accrued wages payable                                                                          275,000

        Unearned revenue                                                                                  489,500

        Accrued interest payable

           ($750,000 X 8% X 8/12)                                                                           40,000

                        Total current liabilities                                                                                      $1,659,500

Long-term liabilities

        Notes payable (due 2007)                                                                       157,400

        8% bonds payable (secured

           by plant and equipment)                                   $   750,000

                Less unamortized bond

                   discount*                                                            42,900                 707,100                   864,500

                        Total liabilities                                                                                                      2,524,000

Stockholders’ equity

        Capital stock, par value

           $10 per share; authorized

           200,000 shares; 184,000

           shares issued and outstanding                         1,840,000

        Paid-in capital in excess of par                                150,000              1,990,000

        Retained earnings                                                                                2,489,000**

                        Total stockholders’ equity                                                                                  4,479,000

                        Total liabilities and

                           stockholders’ equity                                                                                       $7,003,000

 

**($49,500 ÷ 5 = $9,900; $9,900 X 8/12 = $6,600; $49,500 – $6,600 = $42,900)

**Retained earnings                                                    $2,810,600

    Accrued wages omitted                                               (275,000)

    Accrued interest                                                            (40,000)

    Bond amortization                                                           (6,600)

                                                                                       $2,489,000

Additional comments:

1.       The information related to the competitor should be disclosed because this innovation may have a significant effect on the company. The value of the inventory is overstated because of the need to reduce selling prices. This factor along with the net realizable value of the          inventory should be disclosed.

2.       The pledged assets should be described in the balance sheet as indicated or in a footnote.

3.       The error in calculating inventory will have been offset, so no adjustment is needed.

 

4.                     Accrued wages is included as a liability and retained earnings is  reduced.

5.                     The fact that the gain on sale of certain plant assets was credited direct­ly to retained earnings has no effect on the balance sheet presentation.

6.                     Technically, the plant and equipment account should be separately disclosed and depreciation computed on each item individually. However, the information to divide the accounts was not given in this problem.

7.                     Accrued interest on the bonds ($750,000 X 8% X 8/12 = $40,000) was never recorded. This amount will also reduce retained earnings. The related discount amortization [($49,500 ÷ 60) X 8 months = $6,600] will reduce both the discount account and retained earnings.

 

CASE 24-3

 (a)                  The auditor might recommend the following notes be appended to the financial statements in regard to item 2 and item 3.

                        Note A.  In 2004 depreciation of plant assets is computed by the straight-line method. In prior years depreciation was computed using an accelerated method. The new method of depreciation was adopted in recognition of . . . (state justification for the change of depreciation method) . . . and has been applied retroactively to acquisitions of prior years to determine the cumulative effect. The effect of the change in 2004 was to increase (decrease) income before extraordinary item 1 (if any) by xxxx. The adjustment necessary for retroactive application of the new method, amounting to xxxx, is included in income in 2004. The pro-forma amounts shown on the income statement have been adjusted for the effect of retroactive application of depreciation and the pro-forma effect of related income taxes.

 

                        Other Observations

                  1    The change in method of computing depreciation for all fixed assets (previously recorded and future acquisitions) represents a change in accounting principle, as defined by the Accounting Principles Board in Opinion No. 20.

 

                  2.   Accordingly, the cumulative effect of the change should be reflected in the current-year fi­nancial statements, and the financial statements included for comparative purposes should be presented as previously reported.

 

                  3.   As a result of the change to straight-line, the current-year balance sheet will reflect a lower accumulated depreciation amount and the book value of the existing fixed assets will be increased. The current-year income statement will be affected directly in two specific areas: depreciation expense for the current period and an additional category of contra-expense shown after extraordinary items. The additional category of contra-expense is the cumulative effect of the change on the beginning retained earnings of the current period, as though the change had been applied in the earliest applicable period. The amount of this item is deter­mined by recomputing earnings and retained earnings balances for all applicable prior periods as if the change had been applied retroactively. The difference between the recomputed retained earnings balance at the beginning of the current period and the original opening balance of retained earnings in the current period represents the contra-expense amount reflecting the cumulative effect of the change on prior-year financial statements.

 

                        The Accounting Principles Board also concluded that the effect of the change should be disclosed for the current period and on a pro-forma basis for all prior period financial statements included with the current financial statement for comparative purposes. The effect of the change in each instance should be disclosed for income before extraordinary items, net income, and all related per-share amounts.

                        Note B.  The federal income tax return filed by the Corporation for the year 2001 is being examined by the Internal Revenue Service. The Internal Revenue Service has questioned the amount of a de­duction claimed by the Company’s domestic subsidiary for a loss sustained in 2001. The examination by the Internal Revenue Service has not progressed to the point that would indicate the extent of the Company’s liability. The Company’s tax counsel believes that the Company will not be subject to any substantial income tax liability with respect to this matter.

 

(b)      Item 1.  Nonaccounting matters such as management changes and pending proxy fights are not disclosed unless such information is needed for the proper interpretation of the financial statements. The president should be informed that notes are an integral part of the financial             statements and as such should be limited to information that relates to the financial statements. Furthermore, there is no certainty that a proxy fight will materialize and, hence, in view of the uncertainty no reason for note disclosure. Disclosure of events that have no relevance to those matters essential to proper interpretation of the financial statements frequently creates doubt as to the reasons for disclosure and inferences drawn could be misleading. Information about the pending proxy fight might be included in the president’s letter to the stockholders, which is usually in a company’s annual report.

 

 

 

CASE 24-6

 

To:               Vincent Price, Accountant

 

From:          Student

 

Date:           Current date

 

Subject:       Determination of reportable segments for Vender Corp.

 

I have analyzed the segment information which you gave me and determined that the funeral, the cem­etery, and the corporate segments must be reported separately. The remaining three—the limousine, floral, and dried whey segments—can be combined under the category of other.

 

To make this determination, I applied three criteria put forth by the FASB to the information provided from 2004. First, a segment must be reported separately if its revenue is greater than or equal to 10 percent of the enterprise’s combined revenue. This is the case with both the funeral and the cemetery segments as revenue for both is greater than $41,600 (10 percent of combined revenue).

 

Second, a segment is considered significant enough to be reported separately if its absolute operating profit or operating loss is greater than or equal to: (a) the combined operating profit of all segments without an operating loss or (b) the combined operating loss of all segments that incurred a loss. Combined operating profit for all profitable segments totals $101,000. Both the funeral and the cemetery segments have operating profits exceeding total profits whereas the corporate segment’s operating loss is greater than 10 percent of total profits. Thus, all three must be separately reported.

 

Third, a segment must be reported separately if its identifiable assets are greater than or equal to 10 percent of the combined identifiable assets for all segments. Again, the funeral, the cemetery, and the corporate segments meet this test. Note that the limousine, floral, and dried whey segments meet none of the above criteria, so they are not reported separately.

 

When reporting segment information, you must include the following items: revenues, operating profit (loss), identifiable assets, depreciation expense, and amount of capital expenditures. Furthermore, all segment information must be prepared on the same accounting basis as the consolidated entity’s.

 

I hope that this information helps you in determining future reportable segments. If you have any other questions, please contact me.

 

CASE 24-9

 

(a)      1.      The company should report its quarterly results as if each interim period is an integral part of the annual period. (See APB Opinion No. 28, “Interim Financial Reporting.”)

 

          2.      The company’s revenue and expenses would be reported as follows on its quarterly report prepared for the first quarter of the 2003–04 fiscal year:

 

                   Sales                                                                                                                        $60,000,000

                   Cost of goods sold                                                                                                     36,000,000

                   Variable selling expenses                                                                                            2,000,000

                   Fixed selling expenses

                            Advertising ($2,000,000 ÷ 4)                                                                                  500,000

                            Other ($3,000,000 – $2,000,000)                                                                       1,000,000

 

                   Sales and cost of goods sold receive the same treatment as if this were an annual report. Costs and expenses other than product costs should be charged to expense in interim periods as in­curred or allocated among interim periods. Consequently, the variable selling expense and the portion of fixed selling expenses not related to the television advertising should be reported in full. One-fourth of the television advertising is reported as an expense in the first quarter, assuming TV advertising is constant throughout the year. These costs can be deferred within the fiscal period if the benefits of the expenditure clearly extend beyond the interim period in which the expenditure is made.

 

(b)      The financial information to be disclosed to its stockholders in its quarterly reports as a minimum include:

          1.      Sales or gross revenues, provision for income taxes, extraordinary items (including tax effects), cumulative effect of a change in accounting principle, and net income.

          2.      Basic and diluted earnings per share.

          3.      Seasonal revenue, costs or expenses.

 

CASE 24-10

 

(a)      Acceptable. The use of estimated gross profit rates to determine the cost of goods sold is acceptable for interim reporting purposes as long as the method and rates utilized are reasonable. The company should disclose the method employed and any significant adjustments which result from reconciliations with annual physical inventory.

 

(b)      Acceptable. Pension costs are more identifiable with a time period rather than with the sale of a product or service. Companies are encouraged to make quarterly estimates of those items that usu­ally result in year-end adjustments. Consequently, it is acceptable to allocate this expense to each of the four interim periods.

 

(c)      Acceptable. Any loss in inventory value should be reported when the decline occurs. Any recov­eries of the losses on the same inventory in later periods should be recognized as gains in the later interim periods of the same fiscal year. However, the gains should not exceed the previously recorded losses.

 

(d)      Not acceptable. Gains on the sale of investments would not be deferred if they occurred at year-end. Consequently, they should not be deferred to future interim periods but should be reported in the quarter the gain was realized.

 

 

(e)      Acceptable. The annual audit fee is an expense which benefits the company’s entire year. Com­panies are encouraged to make quarterly estimates of these items that usually result in year-end adjustments. Therefore, this expense can be prorated over the four quarters.

 

(f)       Not acceptable. Revenue from products sold should be recognized as earned during the interim period on the same basis as followed for the full year. Because the company normally recognizes a sale when shipment occurs, it should recognize the revenue in the second quarter and not defer the revenue recognition. To do otherwise would be an inconsistent application of company accounting policy and violate general accounting rules for revenue recognition.