CONCEPTS FOR ANALYSIS
CA24-1 (General Disclosures; Inventories; Property, Plant, and Equipment) Koch Corporation is in the process of preparing its annual financial statements for the fiscal year ended April 30, 2018. Because all of Koch’s shares are traded intrastate, the company does not have to file any reports with the Securities and Exchange Commission. The company manufactures plastic, glass, and paper containers for sale to food and drink manufacturers and distributors.
Koch Corporation maintains separate control accounts for its raw materials, work in process, and finished goods inventories for each of the three types of containers. The inventories are valued at the lower-of-cost-or-market.
The company’s property, plant, and equipment are classified in the following major categories: land, office buildings, furniture and fixtures, manufacturing facilities, manufacturing equipment, and leasehold improvements. All fixed assets are carried at cost. The depreciation methods employed depend on the type of asset (its classification) and when it was acquired.
Koch Corporation plans to present the inventory and fixed asset amounts in its April 30, 2018, balance sheet as shown below.
Inventories $4,814,200
Property, plant, and equipment (net of depreciation) 6,310,000
Instructions
What information regarding inventories and property, plant, and equipment must be disclosed by Koch Corporation in the audited financial statements issued to stockholders, either in the body or the notes, for the 2017–2018 fiscal year?
(CMA adapted)
CA24-2 (Disclosures Required in Various Situations) Ace Inc. produces electronic components for sale to manufacturers of radios, television sets, and digital sound systems. In connection with her examination of Ace’s financial statements for the year ended December 31, 2018, Gloria Rodd, CPA, completed field work 2 weeks ago. Ms. Rodd now is evaluating the significance of the following items prior to preparing her auditor’s report. Except as noted, none of these items have been disclosed in the financial statements or notes.
Item 1: A 10-year loan agreement, which the company entered into 3 years ago, provides that dividend payments may not exceed net income earned after taxes subsequent to the date of the agreement. The balance of retained earnings at the date of the loan agreement was $420,000. From that date through December 31, 2018, net income after taxes has totaled $570,000 and cash dividends have totaled $320,000. On the basis of these data, the staff auditor assigned to this review concluded that there was no retained earnings restriction at December 31, 2018.
Item 2: Recently Ace interrupted its policy of paying cash dividends quarterly to its stockholders. Dividends were paid regularly through 2017, discontinued for all of 2018 to finance purchase of equipment for the company’s new plant, and resumed in the first quarter of 2019. In the annual report, dividend policy is to be discussed in the president’s letter to stockholders.
Item 3: A major electronics firm has introduced a line of products that will compete directly with Ace’s primary line, now being produced in the specially designed new plant. Because of manufacturing innovations, the competitor’s line will be of comparable quality but priced 50% below Ace’s line. The competitor announced its new line during the week following completion of field work. Ms. Rodd read the announcement in the newspaper and discussed the situation by telephone with Ace executives. Ace will meet the lower prices that are high enough to cover variable manufacturing and selling expenses but will permit recovery of only a portion of fixed costs.
Item 4: The company’s new manufacturing plant building, which cost $2,400,000 and has an estimated life of 25 years, is leased from Wichita National Bank at an annual rental of $600,000. The company is obligated to pay property taxes, insurance, and maintenance.
At the conclusion of its 10-year noncancelable lease, the company has the option of purchasing the property for $1. In Ace’s income statement, the rental payment is reported on a separate line.
Instructions
For each of the above items, discuss any additional disclosures in the financial statements and notes that the auditor should recommend to her client. (The cumulative effect of the four items should not be considered.)
CA24-3 (Disclosures, Conditional and Contingent Liabilities) Presented below are three independent situations.
Situation 1: A company offers a one-year warranty for the product that it manufactures. A history of warranty claims has been compiled, and the probable amounts of claims related to sales for a given period can be determined.
Situation 2: Subsequent to the date of a set of financial statements but prior to the issuance of the financial statements, a company enters into a contract that will probably result in a significant loss to the company. The amount of the loss can be reasonably estimated.
Situation 3: A company has adopted a policy of recording self-insurance for any possible losses resulting from injury to others by the company’s vehicles. The premium for an insurance policy for the same risk from an independent insurance company would have an annual cost of $4,000. During the period covered by the financial statements, there were no accidents involving the company’s vehicles that resulted in injury to others.
Instructions
Discuss the accrual or type of disclosure necessary (if any) and the reason(s) why such disclosure is appropriate for each of the three independent sets of facts above.
(AICPA adapted)
CA24-4 GROUPWORK (Post-Balance-Sheet Events) At December 31, 2017, Coburn Corp. has assets of $10,000,000, liabilities of $6,000,000, common stock of $2,000,000 (representing 2,000,000 shares of $1 par common stock), and retained earnings of $2,000,000. Net sales for the year 2017 were $18,000,000, and net income was $800,000. As auditors of this company, you are making a review of subsequent events on February 13, 2018, and you find the following.
1. On February 3, 2018, one of Coburn’s customers declared bankruptcy. At December 31, 2017, this company owed Coburn $300,000, of which $60,000 was paid in January 2018.
2. On January 18, 2018, one of the three major plants of the client burned.
3. On January 23, 2018, a strike was called at one of Coburn’s largest plants, which halted 30% of its production. As of today
(February 13), the strike has not been settled.
4. A major electronics enterprise has introduced a line of products that would compete directly with Coburn’s primary line, now being produced in a specially designed new plant. Because of manufacturing innovations, the competitor has been able to achieve quality similar to that of Coburn’s products but at a price 50% lower. Coburn officials say they will meet the lower prices, which are high enough to cover variable manufacturing and selling costs but which permit recovery of only a portion of fixed costs.
5. Merchandise traded in the open market is recorded in the company’s records at $1.40 per unit on December 31, 2017. This price had prevailed for 2 weeks, after release of an official market report that predicted vastly enlarged supplies; however, no purchases were made at $1.40. The price throughout the preceding year had been about $2, which was the level experienced over several years. On January 18, 2018, the price returned to $2, after public disclosure of an error in the official calculations of the prior December, correction of which destroyed the expectations of excessive supplies. Inventory at December 31, 2017, was on a lower-of-LIFO-cost-or-market basis.
6. On February 1, 2018, the board of directors adopted a resolution accepting the offer of an investment banker to guarantee the marketing of $1,200,000 of preferred stock.
Instructions
State in each case how the 2017 financial statements would be affected, if at all.
CA24-5 WRITING (Segment Reporting) You are compiling the consolidated financial statements for Winsor Corporation International. The corporation’s accountant, Anthony Reese, has provided you with the following segment information...
Instructions
Determine which of the above segments must be reported separately and which can be combined under the category “Other.” Then, write a one-page memo to the company’s accountant, Anthony Reese, explaining the following.
(a) What segments must be reported separately and what segments can be combined.
(b) What criteria you used to determine reportable segments.
(c) What major items for each must be disclosed.
CA24-6 (Segment Reporting—Theory) Presented below is an excerpt from the financial statements of H. J. Heinz Company...
Instructions
(a) Why does H. J. Heinz not prepare segment information on its products or services?
(b) What are export sales, and when should they be disclosed?
(c) Why are sales by geographical area important to disclose?
CA24-7 WRITING (Segment Reporting—Theory) The following article appeared in the Wall Street Journal.
Washington—The Securities and Exchange Commission staff issued guidelines for companies grappling with the problem of dividing up their business into industry segments for their annual reports.
An industry segment is defined by the Financial Accounting Standards Board as a part of an enterprise engaged in providing a product or service or a group of related products or services primarily to unaffiliated customers for a profit.
Although conceding that the process is a “subjective task” that “to a considerable extent, depends on the judgment of management,” the SEC staff said companies should consider . . . various factors . . . to determine whether products and services should be grouped together or reported as segments.
Instructions
(a) What does financial reporting for segments of a business enterprise involve?
(b) Identify the reasons for requiring financial data to be reported by segments.
(c) Identify the possible disadvantages of requiring financial data to be reported by segments.
(d) Identify the accounting difficulties inherent in segment reporting.
CA24-8 (Interim Reporting) Snider Corporation, a publicly traded company, is preparing the interim financial data which it will issue to its stockholders and the Securities and Exchange Commission (SEC) at the end of the first quarter of the 2017–2018 fiscal year. Snider’s financial accounting department has compiled the following summarized revenue and expense data for the first quarter of the year.
Sales revenue $60,000,000
Cost of goods sold 36,000,000
Variable selling expenses 1,000,000
Fixed selling expenses 3,000,000
Included in the fixed selling expenses was the single lump-sum payment of $2,000,000 for television advertisements for the entire year.
Instructions
(a) Snider Corporation must issue its quarterly financial statements in accordance with generally accepted accounting principles regarding interim financial reporting.
(1) Explain whether Snider should report its operating results for the quarter as if the quarter were a separate reporting period in and of itself, or as if the quarter were an integral part of the annual reporting period.
(2) State how the sales revenue, cost of goods sold, and fixed selling expenses would be reflected in Snider Corporation’s quarterly report prepared for the first quarter of the 2017–2018 fiscal year. Briefly justify your presentation.
(b) What financial information, as a minimum, must Snider Corporation disclose to its stockholders in its quarterly reports? (CMA adapted)
CA24-9 GROUPWORK (Treatment of Various Interim Reporting Situations) The following statement is an excerpt from the FASB pronouncement related to interim reporting.
Interim financial information is essential to provide investors and others with timely information as to the progress of the enterprise. The usefulness of such information rests on the relationship that it has to the annual results of operations. Accordingly, the Board has concluded that each interim period should be viewed primarily as an integral part of an annual period.
In general, the results for each interim period should be based on the accounting principles and practices used by an enterprise in the preparation of its latest annual financial statements unless a change in an accounting practice or policy has been adopted in the current year. The Board has concluded, however, that certain accounting principles and practices followed for annual reporting purposes may require modification at interim reporting dates so that the reported results for the interim period may better relate to the results of operations for the annual period.
Instructions
The following six independent cases present how accounting facts might be reported on an individual company’s interim financial reports. For each of these cases, state whether the method proposed to be used for interim reporting would be acceptable under generally accepted accounting principles applicable to interim financial data. Support each answer with a brief explanation.
(a) J. D. Long Company takes a physical inventory at year-end for annual financial statement purposes. Inventory and cost of sales reported in the interim quarterly statements are based on estimated gross profit rates, because a physical inventory would result in a cessation of operations. Long Company does have reliable perpetual inventory records.
(b) Rockford Company is planning to report one-fourth of its pension expense each quarter.
(c) Republic Company wrote inventory down to reflect lower-of-cost-or-market in the first quarter. At year-end, the market exceeds the original acquisition cost of this inventory. Consequently, management plans to write the inventory back up to its original cost as a year-end adjustment.
(d) Gansner Company realized a large gain on the sale of investments at the beginning of the second quarter. The company wants to report one-third of the gain in each of the remaining quarters.
(e) Fredonia Company has estimated its annual audit fee. It plans to pro rate this expense equally over all four quarters.
(f) LaBrava Company was reasonably certain it would have an employee strike in the third quarter. As a result, it shipped heavily during the second quarter but plans to defer the recognition of the sales in excess of the normal sales volume.
The deferred sales will be recognized as sales in the third quarter when the strike is in progress. LaBrava Company management thinks this is more representative of normal second- and third-quarter operations.
CA24-10 WRITING (Financial Forecasts) An article in Barron’s noted the following.
Okay. Last fall, someone with a long memory and an even longer arm reached into that bureau drawer and came out with a moldy cheese sandwich and the equally moldy notion of corporate forecasts. We tried to find out what happened to the cheese sandwich—but, rats!, even recourse to the Freedom of Information Act didn’t help. However, the forecast proposal was dusted off, polished up and found quite serviceable. The SEC, indeed, lost no time in running it up the old flagpole—but no one was very eager to salute. Even after some of the more objectionable features—compulsory corrections and detailed explanations of why the estimates went awry—were peeled off the original proposal.
Seemingly, despite the Commission’s smiles and sweet talk, those craven corporations were still afraid that an honest mistake would lead them down the primrose path to consent decrees and class action suits. To lay to rest such qualms, the Commission last week approved a “Safe Harbor” rule that, providing the forecasts were made on a reasonable basis and in good faith, protected corporations from litigation should the projections prove wide of the mark (as only about 99% are apt to do).
Instructions
(a) What are the arguments for preparing profit forecasts?
(b) What is the purpose of the “safe harbor” rule?
(c) Why are corporations concerned about presenting profit forecasts?
CA24-11 ETHICS (Disclosure of Estimates) Nancy Tercek, the financial vice president, and Margaret Lilly, the controller, of Romine Manufacturing Company are reviewing the financial ratios of the company for the years 2017 and 2018. The financial vice president notes that the profit margin on sales ratio has increased from 6% to 12%, a hefty gain for the 2-year period.
Tercek is in the process of issuing a media release that emphasizes the efficiency of Romine Manufacturing in controlling cost.
Margaret Lilly knows that the difference in ratios is due primarily to an earlier company decision to reduce the estimates of warranty and bad debt expense for 2018. The controller, not sure of her supervisor’s motives, hesitates to suggest to Tercek that the company’s improvement is unrelated to efficiency in controlling cost. To complicate matters, the media release is scheduled in a few days.
Instructions
(a) What, if any, is the ethical dilemma in this situation?
(b) Should Lilly, the controller, remain silent? Give reasons.
(c) What stakeholders might be affected by Tercek’s media release?
(d) Give your opinion on the following statement and cite reasons: “Because Tercek, the vice president, is most directly responsible for the media release, Lilly has no real responsibility in this matter.”
CA24-12 ETHICS (Reporting of Subsequent Events) In June 2017, the board of directors for McElroy Enterprises Inc. authorized the sale of $10,000,000 of corporate bonds. Jennifer Grayson, treasurer for McElroy Enterprises Inc., is concerned about the date when the bonds are issued. The company really needs the cash, but she is worried that if the bonds are issued before the company’s year-end (December 31, 2017) the additional liability will have an adverse effect on a number of important ratios. In July, she explains to company president William McElroy that if they delay issuing the bonds until after December 31 the bonds will not affect the ratios until December 31, 2018. They will have to report the issuance as a subsequent event which requires only footnote disclosure. Grayson expects that with expected improved financial performance in 2018, ratios should be better.
Instructions
(a) What are the ethical issues involved?
(b) Should McElroy agree to the delay?
*C A24-13 GROUPWORK (Effect of Transactions on Financial Statements and Ratios) The transactions listed below relate to Wainwright Inc. You are to assume that on the date on which each of the transactions occurred, the corporation’s accounts showed only common stock ($100 par) outstanding, a current ratio of 2.7:1, and a substantial net income for the year to date (before giving effect to the transaction concerned). On that date, the book value per share of stock was $151.53.
Each numbered transaction on the next page is to be considered completely independent of the others, and its related answer should be based on the effect(s) of that transaction alone. Assume that all numbered transactions occurred during 2018 and that the amount involved in each case is sufficiently material to distort reported net income if improperly included in the determination of net income. Assume further that each transaction was recorded in accordance with generally accepted accounting principles and, where applicable, in conformity with the all-inclusive concept of the income statement.
For each of the numbered transactions you are to decide whether it:
(a) Increased the corporation’s 2018 net income.
(b) Decreased the corporation’s 2018 net income.
(c) Increased the corporation’s total retained earnings directly (i.e., not via net income).
(d) Decreased the corporation’s total retained earnings directly.
(e) Increased the corporation’s current ratio.
(f) Decreased the corporation’s current ratio.
(g) Increased each stockholder’s proportionate share of total stockholders’ equity.
(h) Decreased each stockholder’s proportionate share of total stockholders’ equity.
(i) Increased each stockholder’s equity per share of stock (book value).
(j) Decreased each stockholder’s equity per share of stock (book value).
(k) Had none of the foregoing effects.
Instructions
List the numbers 1 through 9. Select as many letters as you deem appropriate to reflect the effect(s) of each transaction as of the date of the transaction by printing beside the transaction number the letter(s) that identifies that transaction’s effect(s).
Transactions _____ 1. In January, the board directed the write-off of certain patent rights that had suddenly and unexpectedly become worthless. _____ 2. The corporation sold at a profit land and a building that had been idle for some time. Under the terms of the sale, the corporation received a portion of the sales price in cash immediately, the balance maturing at 6-month intervals. _____ 3. Treasury stock originally repurchased and carried at $127 per share was sold for cash at $153 per share. _____ 4. The corporation wrote off all of the unamortized discount and issue expense applicable to bonds that it refinanced in
2018. _____ 5. The corporation called in all its outstanding shares of stock and exchanged them for new shares on a 2-for-1 basis, reducing the par value at the same time to $50 per share. _____ 6. The corporation paid a cash dividend that had been recorded in the accounts at time of declaration. _____ 7. Litigation involving Wainwright Inc. as defendant was settled in the corporation’s favor, with the plaintiff paying all court costs and legal fees. In 2015, the corporation had appropriately established a special contingency for this court action. (Indicate the effect of reversing the contingency only.) _____ 8. The corporation received a check for the proceeds of an insurance policy from the company with which it is insured against theft of trucks. No entries concerning the theft had been made previously, and the proceeds reduce but do not cover completely the loss. _____ 9. Treasury stock, which had been repurchased at and carried at $127 per share, was issued as a stock dividend. In connection with this distribution, the board of directors of Wainwright Inc. had authorized a transfer from retained earnings to permanent capital of an amount equal to the aggregate market value ($153 per share) of the shares issued. No entries relating to this dividend had been made previously.
(AICPA adapted)
