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Chapter 24: 4CA_4 (page 1454)

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.

4) A major electronics enterprise has introduced a line of products that would compete directly with Coburn鈥檚 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鈥檚 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.

Instructions

State in each case how the 2017 financial statements would be affected, if at all.

Short Answer

Expert verified

In assessing the appropriate adjustments or disclosures for this transaction, judgment should play an important role.

Step by step solution

01

Meaning of Subsequent event

Any major financial event that occurred after the formal balance sheet date but before the statement was issued should be explained in the notes to the financial statements. These are known as post-balance-sheet events or simply subsequent events.

02

Explaining the effect in the financial statements

If it is the second type of event that provides evidence of circumstances that did not exist as of December 31, 2017, the required disclosure must state:

a) Plant and inventory expenses are not likely to be recovered.

b) The firm may have to spend more money to modify the existing facility.

c) It is impossible to predict future economic events under this circumstance. (If we can figure out what they are Pro-forma data would be useful.)

The financial statements should be revised if it is a subsequent event for which the position existed as of December 31, 2017. If amounts cannot be estimated, GAAP accounting provisions relating to contingencies will apply. It should be emphasized throughout the class that there is no right answer to this dilemma. In assessing the appropriate adjustments or disclosures for this transaction, judgment should play an important role.

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Most popular questions from this chapter

Morlan Corporation is preparing its December 31, 2017, financial statements. Two events that occurred between December 31, 2017, and March 10, 2018, when the statements were authorized for issue, are described below.

  1. A liability, estimated at \(160,000 at December 31, 2017, was settled on February 26, 2018, at \)170,000.
  2. A flood loss of $80,000 occurred on March 1, 2018.

Instructions

What effect do these subsequent events have on 2017 net income?

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鈥檚 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.

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.

Picasso Company is a wholesale distributor of packaging equipment and supplies. The company鈥檚 sales have averaged about \(900,000 annually for the 3-year period 2015鈥�2017. The firm鈥檚 total assets at the end of 2017 amounted to \)850,000.

The president of Picasso Company has asked the controller to prepare a report that summarizes the financial aspects of the company鈥檚 operations for the past 3 years. This report will be presented to the board of directors at their next meeting.

In addition to comparative financial statements, the controller has decided to present a number of relevant financial ratios which can assist in the identification and interpretation of trends. At the request of the controller, the accounting staff has calculated the following ratios for the 3-year period 2015鈥�2017.

2015

2016

2017

Current ratio

1.80

1.89

1.96

Acid-test (quick) ratio

1.04

0.99

0.87

Accounts receivable turnover

8.75

7.71

6.42

Inventory turnover

4.91

4.32

3.42

Debt to assets ratio

51.0%

46.0%

41.0%

Long-term debt to assets ratio

31.0%

27.0%

24.0%

Sales to fixed assets (fixed asset turnover)

1.58

1.69

1.79

Sales as a percent of 2015 sales

1.00

1.03

1.07

Gross margin percentage

36.0%

35.1%

34.6%

Net income to sales

6.9%

7.0%

7.2%

Return on assets

7.7%

7.7%

7.8%

Return on common stockholders鈥� equity

13.6%

13.1%

12.7%

In preparation of the report, the controller has decided first to examine the financial ratios independent of any other data to determine if the ratios themselves reveal any significant trends over the 3-year period.

Instructions

c) Using the ratios provided, what conclusion(s) can be drawn regarding the company鈥檚 net investment in plant and equipment?

鈥淭he significance of financial statement data is not in the amount alone.鈥� Discuss the meaning of this statement.

A close friend of yours, who is a history major and who has not had any college courses or any experience in business, is receiving the financial statements from companies in which he has minor investments (acquired for him by his now-deceased father). He asks you what he needs to know to interpret and evaluate the financial statement data that he is receiving. What would you tell him?
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