Chapter 24 Full Disclosure in Financial Reporting

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Chapter 24 Full Disclosure in Financial Reporting

QUESTIONS

1. What are the major advantages of notes to the financial statements? What types of items are usually reported in notes?
2.
What is the full disclosure principle in accounting? Why has disclosure increased substantially in the last 10 years?
3.
The FASB requires a reconciliation between the effective tax rate and the federal government’s statutory rate. Of what benefit is such a disclosure requirement?
4.
What type of disclosure or accounting do you believe is necessary for the following items? (a) Because of a general increase in the number of labor disputes and strikes, both within and outside the industry, there is an increased likelihood that a company will suffer a costly strike in the near future. (b) A company reports an extraordinary item (net of tax) correctly on the income statement. No other mention is made of this item in the annual report. (c) A company expects to recover a substantial amount in connection with a pending refund claim for a prior year’s taxes. Although the claim is being contested, counsel for the company has confirmed the client’s expectation of recovery.
5.
The following information was described in a note of Canon Packing Co. “During August, Holland Products Corporation purchased 311,003 shares of the Company’s common stock which constitutes approximately 35% of the stock outstanding. Holland has since obtained representation on the Board of Directors.” “An affiliate of Holland Products Corporation acts as a food broker for Canon Packing in the greater New York City marketing area. The commissions for such services after August amounted to approximately $20,000.” Why is this information disclosed?
6.
What are the major types of subsequent events? Indicate how each of the following “subsequent events” would be reported. (a) Collection of a note written off in a prior period. (b) Issuance of a large preferred stock offering. (c) Acquisition of a company in a different industry. (d) Destruction of a major plant in a flood. (e) Death of the company’s chief executive officer (CEO). (f) Additional wage costs associated with settlement of a four-week strike. (g) Settlement of a federal income tax case at considerably more tax than anticipated at year-end. (h) Change in the product mix from consumer goods to industrial goods.
7.
What are diversified companies? What accounting problems are related to diversified companies?
8.
What quantitative materiality test is applied to determine whether a segment is significant enough to warrant separate disclosure?
9.
Identify the segment information that is required to be disclosed by GAAP.
10.
What is an operating segment, and when can information about two operating segments be aggregated?
11.
The controller for Lafayette Inc. recently commented, “If I have to disclose our segments individually, the only people who will gain are our competitors and the only people that will lose are our present stockholders.” Evaluate this comment.
12.
An article in the financial press entitled “Important Information in Annual Reports This Year” noted that annual reports include a management’s discussion and analysis section. What would this section contain?
13.
“The financial statements of a company are management’s, not the accountant’s.” Discuss the implications of this statement.
14.
Olga Conrad, a financial writer, noted recently, “There are substantial arguments for including earnings projections in annual reports and the like. The most compelling is that it would give anyone interested something now available to only a relatively select few—like large stockholders, creditors, and attentive bartenders.” Identify some arguments against providing earnings projections.
15.
The following comment appeared in the financial press: “Inadequate financial disclosure, particularly with respect to how management views the future and its role in the marketplace, has always been a stone in the shoe. After all, if you don’t know how a company views the future, how can you judge the worth of its corporate strategy?” What are some arguments for reporting earnings forecasts?
16.
What are interim reports? Why are balance sheets often not provided with interim data?
17.
What are the accounting problems related to the presentation of interim data?
18.
Dierdorf Inc., a closely held corporation, has decided to go public. The controller, Ed Floyd, is concerned with presenting interim data when a LIFO inventory valuation is used. What problems are encountered with LIFO inventories when quarterly data are presented?
19.
What approaches have been suggested to overcome the seasonality problem related to interim reporting?
20.
What is the difference between a CPA’s unqualified opinion or “clean” opinion and a qualified one?
21.
Jane Ellerby and Sam Callison are discussing the recent fraud that occurred at LowRental Leasing, Inc. The fraud involved the improper reporting of revenue to ensure that the company would have income in excess of $1 million. What is fraudulent financial reporting, and how does it differ from an embezzlement of company funds?
*
22. “The significance of financial statement data is not in the amount alone.” Discuss the meaning of this statement.
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23. 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 to evaluate the financial statement data that he is receiving. What would you tell him?
*
24. Distinguish between ratio analysis and percentage analysis relative to the interpretation of financial statements. What is the value of these two types of analyses?
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25. In calculating inventory turnover, why is cost of goods sold used as the numerator? As the inventory turnover increases, what increasing risk does the business assume?
*
26. What is the relationship of the asset turnover ratio to the rate of return on assets?
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27. Explain the meaning of the following terms: (a) commonsize analysis, (b) vertical analysis, (c) horizontal analysis, (d) percentage analysis.
*
28. Presently, the profession requires that earnings per share be disclosed on the face of the income statement. What are some disadvantages of reporting ratios on the financial statements? BRI E F EXERCI S E S
BE24-1
An annual report of Crestwood Industries states, “The company and its subsidiaries have longterm leases expiring on various dates after December 31, 2012. Amounts payable under such commitments, without reduction for related rental income, are expected to average approximately $5,711,000 annually for the next 3 years. Related rental income from certain subleases to others is estimated to average $3,094,000 annually for the next 3 years.” What information is provided by this note?
BE24-2
An annual report of Ford Motor Corporation states, “Net income a share is computed based upon the average number of shares of capital stock of all classes outstanding. Additional shares of common stock may be issued or delivered in the future on conversion of outstanding convertible debentures, exercise of outstanding employee stock options, and for payment of defined supplemental compensation. Had such additional shares been outstanding, net income a share would have been reduced by 10 in the current year and 3 in the previous year. . . . As a result of capital stock transactions by the company during the current year (primarily the purchase of Class A Stock from Ford Foundation), net income a share was increased by 6.” What information is provided by this note?
BE24-3
Morlan Corporation is preparing its December 31, 2012, financial statements. Two events that occurred between December 31, 2012, and March 10, 2013, when the statements were issued, are described below. 1. A liability, estimated at $160,000 at December 31, 2012, was settled on February 26, 2013, at $170,000. 2. A flood loss of $80,000 occurred on March 1, 2013. What effect do these subsequent events have on 2012 net income?
BE24-4
Tina Bailey, a student of intermediate accounting, was heard to remark after a class discussion on segment reporting, “All this is very confusing to me. First we are told that there is merit in presenting the consolidated results, and now we are told that it is better to show segmental results. I wish they would make up their minds.” Evaluate this comment.
BE24-5
Foley Corporation has seven industry segments with total revenues as follows. Penley $600 Cheng $225 Konami 650 Takuhi 200 KSC 250 Molina 700 Red Moon 275 Based only on the revenues test, which industry segments are reportable? 2 2 2 3 3
BE24-6
Operating profits and losses for the seven industry segments of Foley Corporation are: Penley $ 90 Cheng $ (20) Konami (40) Takuhi 34 KSC 25 Molina 150 Red Moon 50 Based only on the operating profit (loss) test, which industry segments are reportable?
BE24-7
Identifiable assets for the seven industry segments of Foley Corporation are: Penley $500 Cheng $200 Konami 550 Takuhi 150 KSC 250 Molina 475 Red Moon 400 Based only on the identifiable assets test, which industry segments are reportable? *B E24-8 Answer each of the questions in the following unrelated situations. (a) The current ratio of a company is 5:1 and its acid-test ratio is 1:1. If the inventories and prepaid items amount to $500,000, what is the amount of current liabilities? (b) A company had an average inventory last year of $200,000 and its inventory turnover was 5. If sales volume and unit cost remain the same this year as last and inventory turnover is 8 this year, what will average inventory have to be during the current year? (c) A company has current assets of $90,000 (of which $40,000 is inventory and prepaid items) and current liabilities of $40,000. What is the current ratio? What is the acid-test ratio? If the company borrows $15,000 cash from a bank on a 120-day loan, what will its current ratio be? What will the acid-test ratio be? (d) A company has current assets of $600,000 and current liabilities of $240,000. The board of directors declares a cash dividend of $180,000. What is the current ratio after the declaration but before payment? What is the current ratio after the payment of the dividend? *
BE24-9
Heartland Company’s budgeted sales and budgeted cost of goods sold for the coming year are $144,000,000 and $99,000,000, respectively. Short-term interest rates are expected to average 10%. If Heartland can increase inventory turnover from its present level of 9 times a year to a level of 12 times per year, compute its expected cost savings for the coming year. 3 10 10 EXERCI S E S
E24-1 (Post-Balance-Sheet Events)
Keystone Corporation issued its financial statements for the year ended December 31, 2012, on March 10, 2013. The following events took place early in 2013. (a) On January 10, 10,000 shares of $5 par value common stock were issued at $66 per share. (b) On March 1, Keystone determined after negotiations with the Internal Revenue Service that income taxes payable for 2012 should be $1,320,000. At December 31, 2012, income taxes payable were recorded at $1,100,000.
Instructions
Discuss how the preceding post-balance-sheet events should be reflected in the 2012 financial statements.
E24-2 (Post-Balance-Sheet Events)
For each of the following subsequent (post-balance-sheet) events, indicate whether a company should (a) adjust the financial statements, (b) disclose in notes to the financial statements, or (c) neither adjust nor disclose. ______ 1. Settlement of federal tax case at a cost considerably in excess of the amount expected at year-end. ______ 2. Introduction of a new product line. ______ 3. Loss of assembly plant due to fire. ______ 4. Sale of a significant portion of the company’s assets. ______ 5. Retirement of the company president. ______ 6. Issuance of a significant number of shares of common stock. ______ 7. Loss of a significant customer. ______ 8. Prolonged employee strike. ______ 9. Material loss on a year-end receivable because of a customer’s bankruptcy. ______ 10. Hiring of a new president. ______ 11. Settlement of prior year’s litigation against the company. ______ 12. Merger with another company of comparable size.
E24-3 (Segmented Reporting)
LaGreca Company is involved in four separate industries. The following information is available for each of the four industries. Operating Segment Total Revenue Operating Profit (Loss) Identifiable Assets W $ 60,000 $15,000 $167,000 X 10,000 1,500 83,000 Y 23,000 (2,000) 21,000 Z 9,000 1,000 19,000 $102,000 $15,500 $290,000
Instructions
Determine which of the operating segments are reportable based on the: (a) Revenue test. (b) Operating profit (loss) test. (c) Identifiable assets test. *
E24-4 (Ratio Computation and Analysis; Liquidity)
As loan analyst for Madison Bank, you have been presented the following information. Plunkett Co. Herring Co. Assets Cash $ 120,000 $ 320,000 Receivables 220,000 302,000 Inventories 570,000 518,000 Total current assets 910,000 1,140,000 Other assets 500,000 612,000 Total assets $1,410,000 $1,752,000 Liabilities and Stockholders’ Equity Current liabilities $ 300,000 $ 350,000 Long-term liabilities 400,000 500,000 Common stock and retained earnings 710,000 902,000 Total liabilities and stockholders’ equity $1,410,000 $1,752,000 Annual sales $ 930,000 $1,500,000 Rate of gross profi t on sales 30% 40% Each of these companies has requested a loan of $50,000 for 6 months with no collateral offered. In as much as your bank has reached its quota for loans of this type, only one of these requests is to be granted.
Instructions
Which of the two companies, as judged by the information given above, would you recommend as the better risk and why? Assume that the ending account balances are representative of the entire year. *
E24-5 (Analysis of Given Ratios)
Robbins Company is a wholesale distributor of professional equipment and supplies. The company’s sales have averaged about $900,000 annually for the 3-year period 2011–2013. The firm’s total assets at the end of 2013 amounted to $850,000. The president of Robbins Company has asked the controller to prepare a report that summarizes the financial aspects of the company’s 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 2011–2013. 2011 2012 2013 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 3.72 Total debt to total assets 51.0% 46.0% 41.0% Long-term debt to total assets 31.0% 27.0% 24.0% Sales to fi xed assets (fi xed asset turnover) 1.58 1.69 1.79 Sales as a percent of 2011 sales 1.00 1.03 1.05 Gross margin percentage 36.0% 35.1% 34.6% Net income to sales 6.9% 7.0% 7.2% Return on total assets 7.7% 7.7% 7.8% Return on stockholders’ equity 13.6% 13.1% 12.7% 10 10 3 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
(a) The current ratio is increasing while the acid-test (quick) ratio is decreasing. Using the ratios provided, identify and explain the contributing factor(s) for this apparently divergent trend. (b) In terms of the ratios provided, what conclusion(s) can be drawn regarding the company’s use of financial leverage during the 2011–2013 period? (c) Using the ratios provided, what conclusion(s) can be drawn regarding the company’s net investment in plant and equipment?
 *E 24-6 (Ratio Analysis) Howser Inc. is a manufacturer of electronic components and accessories with total assets of $20,000,000. Selected financial ratios for Howser and the industry averages for firms of similar size are presented below. 2013 Howser Industry 2011 2012 2013 Average Current ratio 2.09 2.27 2.51 2.24 Quick ratio 1.15 1.12 1.19 1.22 Inventory turnover 2.40 2.18 2.02 3.50 Net sales to stockholders’ equity 2.75 2.80 2.95 2.85 Net income to stockholders’ equity 0.14 0.15 0.17 0.11 Total liabilities to stockholders’ equity 1.41 1.37 1.44 0.95 Howser is being reviewed by several entities whose interests vary, and the company’s financial ratios are a part of the data being considered. Each of the parties listed below must recommend an action based on its evaluation of Howser’s financial position. Citizens National Bank. The bank is processing Howser’s application for a new 5-year term note. Citizens National has been Howser’s banker for several years but must reevaluate the company’s financial position for each major transaction. Charleston Company. Charleston is a new supplier to Howser and must decide on the appropriate credit terms to extend to the company. Shannon Financial. A brokerage firm specializing in the stock of electronics firms that are sold overthe- counter, Shannon Financial must decide if it will include Howser in a new fund being established for sale to Shannon Financial’s clients. Working Capital Management Committee. This is a committee of Howser’s management personnel chaired by the chief operating officer. The committee is charged with the responsibility of periodically reviewing the company’s working capital position, comparing actual data against budgets, and recommending changes in strategy as needed.
Instructions
(a) Describe the analytical use of each of the six ratios presented above. (b) For each of the four entities described above, identify two financial ratios, from those ratios presented in Illustration 24A-1 (on page 1549), that would be most valuable as a basis for its decision regarding Howser. (c) Discuss what the financial ratios presented in the question reveal about Howser. Support your answer by citing specific ratio levels and trends as well as the interrelationships between these ratios. (CMA adapted) 10 PROBLEMS
P24-1 (Subsequent Events)
Your firm has been engaged to examine the financial statements of Almaden Corporation for the year 2012. The bookkeeper who maintains the financial records has prepared all the unaudited financial statements for the corporation since its organization on January 2, 2007. The client provides you with the information on the next page. 2 The supplementary information below is also provided. 1. On May 1, 2012, the corporation issued at 95.4, $750,000 of bonds to finance plant expansion. The long-term bond agreement provided for the annual payment of interest every May 1. The existing plant was pledged as security for the loan. Use the straight-line method for discount amortization. 2. The bookkeeper made the following mistakes. (a) In 2010, the ending inventory was overstated by $183,000. The ending inventories for 2011 and 2012 were correctly computed. (b) In 2012, accrued wages in the amount of $225,000 were omitted from the balance sheet, and these expenses were not charged on the income statement. (c) In 2012, a gain of $175,000 (net of tax) on the sale of certain plant assets was credited directly to retained earnings. 3. A major competitor has introduced a line of products that will compete directly with Almaden’s primary line, now being produced in a specially designed new plant. Because of manufacturing innovations, the competitor’s line will be of comparable quality but priced 50% below Almaden’s line. The competitor announced its new line on January 14, 2013. Almaden indicates that the company will meet the lower prices that are high enough to cover variable manufacturing and selling expenses, but permit recovery of only a portion of fixed costs. ALMADEN CORPORATION BALANCE SHEET DECEMBER 31, 2012 Assets Liabilities Current assets $1,881,100 Current liabilities $ 962,400 Other assets 5,171,400 Long-term liabilities 1,439,500 Capital 4,650,600 $7,052,500 $7,052,500 An analysis of current assets discloses the following. Cash (restricted in the amount of $300,000 for plant expansion) $ 571,000 Investments in land 185,000 Accounts receivable less allowance of $30,000 480,000 Inventories (LIFO fl ow assumption) 645,100 $1,881,100 Other assets include: Prepaid expenses $ 62,400 Plant and equipment less accumulated depreciation of $1,430,000 4,130,000 Cash surrender value of life insurance policy 84,000 Unamortized bond discount 34,500 Notes receivable (short-term) 162,300 Goodwill 252,000 Land 446,200 $5,171,400 Current liabilities include: Accounts payable $ 510,000 Notes payable (due 2015) 157,400 Estimated income taxes payable 145,000 Premium on common stock 150,000 $ 962,400 Long-term liabilities include: Unearned revenue $ 489,500 Dividends payable (cash) 200,000 8% bonds payable (due May 1, 2017) 750,000 $1,439,500 Capital includes: Retained earnings $2,810,600 Common stock, par value $10; authorized 200,000 shares, 184,000 shares issued 1,840,000 $4,650,600 4. You learned on January 28, 2013, prior to completion of the audit, of heavy damage because of a recent fire to one of Almaden’s two plants; the loss will not be reimbursed by insurance. The newspapers described the event in detail.
Instructions
Analyze the above information to prepare a corrected balance sheet for Almaden in accordance with proper accounting and reporting principles. Prepare a description of any notes that might need to be prepared. The books are closed and adjustments to income are to be made through retained earnings.
P24-2 (Segmented Reporting)
Cineplex Corporation is a diversified company that operates in five different industries: A, B, C, D, and E. The following information relating to each segment is available for 2013. A B C D E Sales revenue $40,000 $ 75,000 $580,000 $35,000 $55,000 Cost of goods sold 19,000 50,000 270,000 19,000 30,000 Operating expenses 10,000 40,000 235,000 12,000 18,000 Total expenses 29,000 90,000 505,000 31,000 48,000 Operating profi t (loss) $11,000 $(15,000) $ 75,000 $ 4,000 $ 7,000 Identifi able assets $35,000 $ 80,000 $500,000 $65,000 $50,000 Sales of segments B and C included intersegment sales of $20,000 and $100,000, respectively.
Instructions
(a) Determine which of the segments are reportable based on the: (1) Revenue test. (2) Operating profit (loss) test. (3) Identifiable assets test. (b) Prepare the necessary disclosures required by GAAP. *
P24-3 (Ratio Computations and Additional Analysis)
Bradburn Corporation was formed 5 years ago through a public subscription of common stock. Daniel Brown, who owns 15% of the common stock, was one of the organizers of Bradburn and is its current president. The company has been successful, but it currently is experiencing a shortage of funds. On June 10, Daniel Brown approached the Topeka National Bank, asking for a 24-month extension on two $35,000 notes, which are due on June 30, 2013, and September 30, 2013. Another note of $6,000 is due on March 31, 2014, but he expects no difficulty in paying this note on its due date. Brown explained that Bradburn’s cash flow problems are due primarily to the company’s desire to finance a $300,000 plant expansion over the next 2 fiscal years through internally generated funds. The commercial loan officer of Topeka National Bank requested financial reports for the last 2 fiscal years. These reports are reproduced below and on page 1562. 10 12 Problems 1561 3 BRADBURN CORPORATION BALANCE SHEET MARCH 31 Assets 2013 2012 Cash $ 18,200 $ 12,500 Notes receivable 148,000 132,000 Accounts receivable (net) 131,800 125,500 Inventories (at cost) 105,000 50,000 Plant & equipment (net of depreciation) 1,449,000 1,420,500 Total assets $1,852,000 $1,740,500 Liabilities and Stockholders’ Equity Accounts payable $ 79,000 $ 91,000 Notes payable 76,000 61,500 Accrued liabilities 9,000 6,000 Common stock (130,000 shares, $10 par) 1,300,000 1,300,000 Retained earningsa 388,000 282,000 Total liabilities and stockholders’ equity $1,852,000 $1,740,500 aCash dividends were paid at the rate of $1 per share in fi scal year 2012 and $2 per share in fi scal year 2013.
Instructions
(a) Compute the following items for Bradburn Corporation. (1) Current ratio for fiscal years 2012 and 2013. (2) Acid-test (quick) ratio for fiscal years 2012 and 2013. (3) Inventory turnover for fiscal year 2013. (4) Return on assets for fiscal years 2012 and 2013. (Assume total assets were $1,688,500 at 3/31/11.) (5) Percentage change in sales, cost of goods sold, gross margin, and net income after taxes from fiscal year 2012 to 2013. (b) Identify and explain what other financial reports and/or financial analyses might be helpful to the commercial loan officer of Topeka National Bank in evaluating Daniel Brown’s request for a time extension on Bradburn’s notes. (c) Assume that the percentage changes experienced in fiscal year 2013 as compared with fiscal year 2012 for sales and cost of goods sold will be repeated in each of the next 2 years. Is Bradburn’s desire to finance the plant expansion from internally generated funds realistic? Discuss. (d) Should Topeka National Bank grant the extension on Bradburn’s notes considering Daniel Brown’s statement about financing the plant expansion through internally generated funds? Discuss.
*
P 24-4 (Horizontal and Vertical Analysis) Presented below are comparative balance sheets for the Gilmour Company. BRADBURN CORPORATION INCOME STATEMENT FOR THE FISCAL YEARS ENDED MARCH 31 2013 2012 Sales revenue $3,000,000 $2,700,000 Cost of goods solda 1,530,000 1,425,000 Gross margin 1,470,000 1,275,000 Operating expenses 860,000 780,000 Income before income taxes 610,000 495,000 Income taxes (40%) 244,000 198,000 Net income $ 366,000 $ 297,000 aDepreciation charges on the plant and equipment of $100,000 and $102,500 for fi scal years ended March 31, 2012 and 2013, respectively, are included in cost of goods sold. 13 GILMOUR COMPANY COMPARATIVE BALANCE SHEET AS OF DECEMBER 31, 2013 AND 2012 December 31 2013 2012 Assets Cash $ 180,000 $ 275,000 Accounts receivable (net) 220,000 155,000 Short-term investments 270,000 150,000 Inventories 1,060,000 980,000 Prepaid expenses 25,000 25,000 Fixed assets 2,585,000 1,950,000 Accumulated depreciation (1,000,000) (750,000) $3,340,000 $2,785,000 Liabilities and Stockholders’ Equity Accounts payable $ 50,000 $ 75,000 Accrued expenses 170,000 200,000 Bonds payable 450,000 190,000 Capital stock 2,100,000 1,770,000 Retained earnings 570,000 550,000 $3,340,000 $2,785,000
Instructions
(Round to two decimal places.) (a) Prepare a comparative balance sheet of Gilmour Company showing the percent each item is of the total assets or total liabilities and stockholders’ equity. (b) Prepare a comparative balance sheet of Gilmour Company showing the dollar change and the percent change for each item. (c) Of what value is the additional information provided in part (a)? (d) Of what value is the additional information provided in part (b)? *
P24-5 (Dividend Policy Analysis)
Matheny Inc. went public 3 years ago. The board of directors will be meeting shortly after the end of the year to decide on a dividend policy. In the past, growth has been financed primarily through the retention of earnings. A stock or a cash dividend has never been declared. Presented below is a brief financial summary of Matheny Inc. operations. ($000 omitted) 2013 2012 2011 2010 2009 Sales revenue $20,000 $16,000 $14,000 $6,000 $4,000 Net income 2,400 1,400 800 700 250 Average total assets 22,000 19,000 11,500 4,200 3,000 Current assets 8,000 6,000 3,000 1,200 1,000 Working capital 3,600 3,200 1,200 500 400 Common shares: Number of shares outstanding (000) 2,000 2,000 2,000 20 20 Average market price $9 $6 $4 — —
Instructions
(a) Suggest factors to be considered by the board of directors in establishing a dividend policy. (b) Compute the rate of return on assets, profit margin on sales, earnings per share, price-earnings ratio, and current ratio for each of the 5 years for Matheny Inc. (c) Comment on the appropriateness of declaring a cash dividend at this time, using the ratios computed in part (b) as a major factor in your analysis. 10 CONCEPTS FOR ANALYS I S
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, 2013. 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 lowerof- 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, 2013, 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 2012–2013 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, 2013, 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, 2013, 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, 2013. Item 2 Recently Ace interrupted its policy of paying cash dividends quarterly to its stockholders. Dividends were paid regularly through 2012, discontinued for all of 2013 to finance purchase of equipment for the company’s new plant, and resumed in the first quarter of 2014. 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 (Post-Balance-Sheet Events)
At December 31, 2012, 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 2012 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, 2013, and you find the following. 1. On February 3, 2013, one of Coburn’s customers declared bankruptcy. At December 31, 2012, this company owed Coburn $300,000, of which $60,000 was paid in January 2013. 2. On January 18, 2013, one of the three major plants of the client burned. 3. On January 23, 2013, 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, 2012. 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, 2013, 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, 2012, was on a lower-of-cost-or-market basis. 6. On February 1, 2013, 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 2012 financial statements would be affected, if at all.
CA24-5 (Segment Reporting)
You are compiling the consolidated financial statements for Winsor Corporation International. The corporation’s accountant, Anthony Reese, has provided you with the segment information shown below. Note 7: Major Segments of Business WCI conducts funeral service and cemetery operations in the United States and Canada. Substantially all revenues of WCI’s major segments of business are from unaffi liated customers. Segment information for fi scal 2013, 2012, and 2011 follows. (thousands) Funeral Floral Cemetery Real Estate Dried Whey Limousine Consolidated Revenues 2013 $302,000 $10,000 $ 73,000 $ 2,000 $7,000 $12,000 $406,000 2012 245,000 6,000 61,000 4,000 4,000 4,000 324,000 2011 208,000 3,000 42,000 3,000 1,000 3,000 260,000 Operating Income 2013 74,000 1,500 18,000 (36,000) 500 2,000 60,000 2012 64,000 200 12,000 (28,000) 200 400 48,800 2011 54,000 150 6,000 (21,000) 100 350 39,600 Capital Expenditures 2013 26,000 1,000 9,000 400 300 1,000 37,700 2012 28,000 2,000 60,000 1,500 100 700 92,300 2011 14,000 25 8,000 600 25 50 22,700 Depreciation and Amortization 2013 13,000 100 2,400 1,400 100 200 17,200 2012 10,000 50 1,400 700 50 100 12,300 2012 8,000 25 1,000 600 25 50 9,700 Identifi able Assets 2013 334,000 1,500 162,000 114,000 500 8,000 620,000 2012 322,000 1,000 144,000 52,000 1,000 6,000 526,000 2011 223,000 500 78,000 34,000 500 3,500 339,500
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. Segment and Geographic Data The company is engaged principally in one line of business—processed food products—which represents over 90% of consolidated sales. Information about the business of the company by geographic area is presented in the table below. There were no material amounts of sales or transfers between geographic areas or between affi liates, and no material amounts of United States export sales. Foreign (in thousands of United Western U.S. dollars) Domestic Kingdom Canada Europe Other Total Worldwide Sales $2,381,054 $547,527 $216,726 $383,784 $209,354 $1,357,391 $3,738,445 Operating income 246,780 61,282 34,146 29,146 25,111 149,685 396,465 Identifi able assets 1,362,152 265,218 112,620 294,732 143,971 816,541 2,178,693 Capital expenditures 72,712 12,262 13,790 8,253 4,368 38,673 111,385 Depreciation expense 42,279 8,364 3,592 6,355 3,606 21,917 64,196
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 (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 2012–2013 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 2012–2013 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 (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
Listed below are six independent cases on 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 (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 (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 2012 and 2013. 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 2013. 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 (Reporting of Subsequent Events)
In June 2012, 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, 2012) 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, 2013. 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 2013 ratios should be better.
Instructions
(a) What are the ethical issues involved? (b) Should McElroy agree to the delay? *
CA24-13 (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 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 2013 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 2013 net income. (b) Decreased the corporation’s 2013 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 2013. _____ 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 2010, 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) Gateway to the Profession Additional Financial Statement Analysis Problems USING YOUR JUDGMENT FINANCIAL REPORTING Financial Reporting Problem The Procter & Gamble Company (P&G) As stated in the chapter, notes to the financial statements are the means of explaining the items presented in the main body of the statements. Common note disclosures relate to such items as accounting policies, segmented information, and interim reporting. The financial statements of P&G are provided in Appendix 5B or can be accessed at the book’s companion website, www.wiley.com/college/kieso.
Instructions
Refer to P&G’s financial statements and the accompanying notes to answer the following questions. (a) What specific items does P&G discuss in its Note 1—Summary of Significant Accounting Policies? (List the headings only.) (b) For what segments did P&G report segmented information? Which segment is the largest? Who is P&G’s largest customer? (c) What interim information was reported by P&G? Using Your Judgment 1569 Comparative Analysis Case The Coca-Cola Company and PepsiCo, Inc.
Instructions
Go to the book’s companion website and use information found there to answer the following questions related to The Coca-Cola Company and PepsiCo, Inc. (a) (1) What specifi c items does Coca-Cola discuss in its Note 1—Accounting Policies? (Prepare a list of the headings only.) (2) What specifi c items does PepsiCo discuss in its Note 2—Our Summary of Signifi cant Accounting Policies? (Prepare a list of the headings only.) (b) For what lines of business or segments do Coca-Cola and PepsiCo present segmented information? (c) Note and comment on the similarities and differences between the auditors’ reports submitted by the independent auditors of Coca-Cola and PepsiCo for the year 2009. *Financial Statement Analysis Case RNA Inc. manufactures a variety of consumer products. The company’s founders have run the company for 30 years and are now interested in retiring. Consequently, they are seeking a purchaser who will continue its operations, and a group of investors, Morgan Inc., is looking into the acquisition of RNA. To evaluate its financial stability and operating efficiency, RNA was requested to provide the latest financial statements and selected financial ratios. Summary information provided by RNA is presented below and on the next page. RNA INC. INCOME STATEMENT FOR THE YEAR ENDED NOVEMBER 30, 2013 (IN THOUSANDS) Sales (net) $30,500 Interest income 500 Total revenue 31,000 Costs and expenses Cost of goods sold 17,600 Selling and administrative expenses 3,550 Depreciation and amortization expense 1,890 Interest expense 900 Total costs and expenses 23,940 Income before taxes 7,060 Income taxes 2,800 Net income $ 4,260 RNA INC. BALANCE SHEET AS OF NOVEMBER 30 (IN THOUSANDS) 2013 2012 Cash $ 400 $ 500 Short-term investments (at cost) 300 200 Accounts receivable (net) 3,200 2,900 Inventory 6,000 5,400 Total current assets 9,900 9,000 Property, plant, & equipment (net) 7,100 7,000 Total assets $17,000 $16,000 Using Your Judgment 1571 Accounts payable $ 3,700 $ 3,400 Income taxes payable 900 800 Accrued expenses 1,700 1,400 Total current liabilities 6,300 5,600 Long-term debt 2,000 1,800 Total liabilities 8,300 7,400 Common stock ($1 par value) 2,700 2,700 Paid-in capital in excess of par 1,000 1,000 Retained earnings 5,000 4,900 Total stockholders’ equity 8,700 8,600 Total liabilities and stockholders’ equity $17,000 $16,000 SELECTED FINANCIAL RATIOS Current RNA INC. Industry 2012 2011 Average Current ratio 1.61 1.62 1.63 Acid-test ratio .64 .63 .68 Times interest earned 8.55 8.50 8.45 Profi t margin on sales 13.2% 12.1% 13.0% Asset turnover 1.84 1.83 1.84 Inventory turnover 3.17 3.21 3.18
Instructions
(a) Calculate a new set of ratios for the fiscal year 2013 for RNA based on the financial statements presented. (b) Explain the analytical use of each of the six ratios presented, describing what the investors can learn about RNA’s financial stability and operating efficiency. (c) Identify two limitations of ratio analysis. (CMA adapted)
Accounting, Analysis, and Principles
Savannah, Inc. is a company that manufactures and sells a single product. Unit sales for each of the four quarters of 2012 are projected as follows. Quarter Units First 80,000 Second 150,000 Third 550,000 Fourth 120,000 Annual Total 900,000 Savannah incurs variable manufacturing costs of $0.40 per unit and variable nonmanufacturing costs of $0.35 per unit. Savannah will incur fixed manufacturing costs of $720,000 and fixed nonmanufacturing costs of $1,080,000. Savannah will sell its product for $4.00 per unit. Accounting Determine the amount of net income Savannah will report in each of the four quarters of 2012, assuming actual sales are as projected and employing the integral approach to interim financial reporting. (Ignore income taxes.)
Analysis
Compute Savannah’s profit margin on sales for each of the four quarters of 2012. What effect does employing the integral approach instead of the discrete approach have on the degree to which Savannah’s profit margin on sales varies from quarter to quarter?
Principles
Explain the conceptual rationale behind the integral approach to interim financial reporting. 2013 2012
BRIDGE TO THE PROFESSION

Professional Research: FASB Codifi cation
As part of the year-end audit, you are discussing the disclosure checklist with your client. The checklist identifies the items that must be disclosed in a set of GAAP financial statements. The client is surprised by the disclosure item related to accounting policies. Specifically, since the audit report will attest to the statements being prepared in accordance with GAAP, the client questions the accounting policy checklist item. The client has asked you to conduct some research to verify the accounting policy disclosures.
Instructions
If your school has a subscription to the FASB Codification, go to http://aaahq.org/ascLogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses. (a) In general, what should disclosures of accounting policies encompass? (b) List some examples of the most commonly required disclosures.
*
Professional Simulation In this simulation, you are asked to evaluate a company’s solvency and going-concern potential, by analyzing a set of ratios. You also are asked to indicate possible limitations of ratio analysis. Prepare responses to all parts. The data requested and the computations developed from the financial statements follow. As the CPA for Packard Clipper, Inc., you have been requested to develop some key ratios from the comparative financial statements. This information is to be used to convince creditors that Packard Clipper, Inc. is solvent and to support the use of going-concern valuation procedures in the financial statements. Packard Clipper asks you to prepare a list of brief comments stating how each of these items supports the solvency and going-concern potential of the business. The company wishes to use these comments to support its presentation of data to its creditors. You are to prepare the comments as requested, giving the implications and the limitations of each item separately, and then the collective inference that may be drawn from them about Packard Clipper’s solvency and going-concern potential. Having done as the client requested in the Analysis section above, prepare a brief listing of additional ratio-analysis-type data for this client which you think its creditors are going to ask for to supplement the analytical data you provided. Explain why you think the additional data will be helpful to these creditors in evaluating the client’s solvency. What warnings should you offer these creditors about the limitations of ratio analysis for the purposes stated here? Directions Situation Analysis Explanation Resources Directions Situation Analysis Explanation Resources Directions Situation Analysis Explanation Resources 2012 2011 Current ratio 2.6 times 2.1 times Acid-test ratio .8 times 1.3 times Property, plant, and equipment to stockholders’ equity 2.5 times 2.2 times Sales to stockholders’ equity 2.4 times 2.7 times Net income Up 32% Down 9% Earnings per share $3.30 $2.50 Book value per share Up 6% Up 9% + KWW_Professional_Simulation Financial Ratio Analysis Time Remaining 0 hours 40 minutes Unsplit Split Horiz Split Vertical Spreadsheet Calculator Exit IFRS and GAAP disclosure requirements are similar in many regards. The IFRS addressing various disclosure issues are IAS 24 (“Related Party Disclosures”), disclosure and recognition of post-statement of financial position events in IAS 10 (“Events after the Balance Sheet Date”), segment reporting IFRS provisions in IFRS 8 (“Operating Segments”), and interim reporting requirements in IAS 34 (“Interim Financial Reporting”).
RELEVANT FACTS
• Due to the broader range of judgments allowed in more principles-based IFRS, note disclosures generally are more expansive under IFRS compared to GAAP. • GAAP and IFRS have similar standards on post-statement of fi nancial position (subsequent) events. That is, under both sets of standards, events that occurred after the statement of fi nancial position date, and which provide additional evidence of conditions that existed at the statement of fi nancial position date, are recognized in the fi nancial statements. Subsequent events under IFRS are evaluated through the date that fi nancial instruments are “authorized for issue.” GAAP uses the date when fi nancial statements are “issued.” Also, for share dividends and splits in the subsequent period, IFRS does not adjust but GAAP does. • Like GAAP, IFRS requires that for transactions with related parties, companies disclose the amounts involved in a transaction; the amount, terms, and nature of the outstanding balances; and any doubtful amounts related to those outstanding balances for each major category of related parties. There is no specifi c requirement to disclose the name of the related party. • Following the recent issuance of IFRS 8, “Operating Segments,” the requirements under IFRS and GAAP are very similar. That is, both standards use the management approach to identify reportable segments, and similar segment disclosures are required. • Neither GAAP nor IFRS require interim reports. Rather, the SEC and stock exchanges outside the United States establish the rules. In the United States, interim reports generally are provided on a quarterly basis; outside the United States, six-month interim reports are common.
ABOUT THE NUMBERS

Differential Disclosure
A trend toward differential disclosure is occurring. The IASB has developed IFRS for small- and medium-sized entities (SMEs). SMEs are entities that publish general- purpose financial statements for external users but do not issue shares or other securities in a public market. Many believe a simplified set of standards makes sense for these companies because they do not have the resources to implement full IFRS. Simplified IFRS for SMEs is a single standard of fewer than 230 pages. It is designed to meet the needs and capabilities of SMEs, which are estimated to account for over 95 percent of all companies around the world. Compared with full IFRS (and many national accounting standards), simplified IFRS for SMEs is less complex in a number of ways: • Topics not relevant for SMEs are omitted. Examples are earnings per share, interim fi nancial reporting, and segment reporting. • Simplifi ed IFRS for SMEs allows fewer accounting policy choices. Examples are no option to revalue property, equipment, or intangibles, and no corridor approach for actuarial gains and losses. IFRS Insights 1573 • Many principles for recognizing and measuring assets, liabilities, revenue, and expenses are simplifi ed. For example, goodwill is amortized (as a result, there is no annual impairment test), and all borrowing and R&D costs are expensed. • Signifi cantly fewer disclosures are required (roughly 300 versus 3,000). • To further reduce standard overload, revisions to the IFRS for SMEs will be limited to once every three years. Thus, the option of using simplified IFRS helps SMEs meet the needs of their financial statement users while balancing the costs and benefits from a preparer perspective.32
Events after the Reporting Period (Subsequent Events)
Notes to the financial statements should explain any significant financial events that took place after the formal statement of financial position date, but before the statements are authorized for issuance (hereafter referred to as the authorization date). These events are referred to as events after the reporting date, or subsequent events. Illustration
IFRS24-1 shows a time diagram of the subsequent events period.
32In the United States, there has been a preference for one set of GAAP except in unusual situations. With the advent of simplified IFRS for SMEs, this position is under review. Both the FASB and the AICPA are studying the big GAAP/little GAAP issue to ensure that any kind of differential reporting is conceptually sound and meets the needs of users. The FASB has formed a Private Company Financial Reporting Committee, whose primary objectives are to provide recommendations on FASB standard-setting for privately held enterprises (see http://www.pcfr.org/ ). Jan. 1, 2012 Statement of Financial Position Date Financial Statements Authorization Date Dec. 31, 2012 Mar. 3, 2013
Financial Statement Period Subsequent Events Period

ILLUSTRATION
IFRS24-1
Time Periods for Subsequent Events A period of several weeks, and sometimes months, may elapse after the end of the fiscal year but before the management or the board of directors authorizes issuance of the financial statements. Various activities involved in closing the books for the period and issuing the statements all take time: taking and pricing the inventory, reconciling subsidiary ledgers with controlling accounts, preparing necessary adjusting entries, ensuring that all transactions for the period have been entered, obtaining an audit of the financial statements by independent certified public accountants, and printing the annual report. During the period between the statement of financial position date and its authorization date, important transactions or other events may occur that materially affect the company’s financial position or operating situation. Many who read a statement of financial position believe the financial condition is constant, and they project it into the future. However, readers must be told if the company has experienced a significant change—e.g., sold one of its plants, acquired a subsidiary, suffered unusual losses, settled significant litigation, or experienced any other important event in the post-statement of financial position period. Without an explanation in a note, the reader might be misled and draw inappropriate conclusions. Two types of events or transactions occurring after the statement of financial position date may have a material effect on the financial statements or may need disclosure so that readers interpret these statements accurately: 1. Events that provide additional evidence about conditions that existed at the statement of fi nancial position date, including the estimates inherent in the process of preparing fi nancial statements. These events are referred to as adjusted subsequent events and require adjustments to the fi nancial statements. All information available prior to the authorization date of the fi nancial statements helps investors and creditors evaluate estimates previously made. To ignore these subsequent events is to pass up an opportunity to improve the accuracy of the fi nancial statements. This fi rst type of event encompasses information that an accountant would have recorded in the accounts had the information been known at the statement of fi nancial position date. For example, if a loss on an account receivable results from a customer’s bankruptcy subsequent to the statement of fi nancial position date, the company adjusts the fi nancial statements before their issuance. The bankruptcy stems from the customer’s poor fi nancial health existing at the statement of fi nancial position date. The same criterion applies to settlements of litigation. The company must adjust the fi nancial statements if the events that gave rise to the litigation, such as personal injury or patent infringement, took place prior to the statement of fi nancial position date. 2. Events that provide evidence about conditions that did not exist at the statement of fi nancial position date but arise subsequent to that date. These events are referred to as non-adjusted subsequent events and do not require adjustment of the fi nancial statements. To illustrate, a loss resulting from a customer’s fi re or fl ood after the statement of fi nancial position date does not refl ect conditions existing at that date. Thus, adjustment of the fi nancial statements is not necessary. A company should not recognize subsequent events that provide evidence about conditions that did not exist at the date of the statement of fi nancial position but that arose after the statement of fi nancial position date. The following are examples of non-adjusted subsequent events: A major business combination after the reporting period or disposing of a major subsidiary. Announcing a plan to discontinue an operation or commencing the implementation of a major restructuring. Major purchases of assets, other disposals of assets, or expropriation of major assets by government. The destruction of a major production plant or inventories by a fi re or natural disaster after the reporting period. Major ordinary share transactions and potential ordinary share transactions after the reporting period. Abnormally large changes after the reporting period in asset prices, foreign exchange rates, or taxes. Entering into signifi cant commitments or contingent liabilities, for example, by issuing signifi cant guarantees after the statement date.33
IFRS Insights
1575 33The effects from natural disasters, like the recent eruption of the Icelandic volcano, which occurred after the year-end for companies with March fiscal years, require disclosure in order to keep the statements from being misleading. Some companies may have to consider whether these disasters affect their ability to continue as going concerns. Many subsequent events or developments do not require adjustment of or disclosure in the financial statements. Typically, these are non-accounting events or conditions that management normally communicates by other means. These events include legislation, product changes, management changes, strikes, unionization, marketing agreements, and loss of important customers.
Interim Reports
Another source of information for the investor is interim reports. As noted earlier, interim reports cover periods of less than one year. The securities exchanges, market regulators, and the accounting profession have an active interest in the presentation of interim information. Because of the short-term nature of the information in these reports, there is considerable controversy as to the general approach companies should employ. One group, which favors the discrete approach, believes that companies should treat each interim period as a separate accounting period. Using that treatment, companies would follow the principles for deferrals and accruals used for annual reports. In this view, companies should report accounting transactions as they occur, and expense recognition should not change with the period of time covered. Another group, which favors the integral approach, believes that the interim report is an integral part of the annual report and that deferrals and accruals should take into consideration what will happen for the entire year. In this approach, companies should assign estimated expenses to parts of a year on the basis of sales volume or some other activity base. In general, IFRS requires companies to follow the discrete approach.
Interim Reporting Requirements
Under IFRS, companies should use the same accounting policies for interim reports and for annual reports. They should recognize revenues in interim periods on the same basis as they are for annual periods. For example, if Cedars Corp. uses the percentageof- completion method as the basis for recognizing revenue on an annual basis, it should use the percentage-of-completion method for interim reports as well. Also, Cedars Some non-adjusted subsequent events may have to be disclosed to keep the financial statements from being misleading. For such events, a company discloses the nature of the event and an estimate of its financial effect. Illustration
IFRS24-2 presents an example of subsequent events disclosure, excerpted from the annual report of
Cadbury plc.
ILLUSTRATION
IFRS24-2
Disclosure of Subsequent Events
Cadbury plc
Note 38. Events After the Balance Sheet Date On 23 January 2009, the Group obtained committed credit facilities totalling 300 million. This facility expires at the earlier of the disposal of Australia Beverages, capital market debt or equity issuance or 28 February 2010. On 4 March 2009, the Group issued a 300 million bond that matures in 2014. On issuance of the bond the 300 million committed credit facilities expired. The Group announced that it had entered into a conditional agreement with Asahi Breweries, Ltd (“Asahi”) on 24 December 2008 to sell the Australia Beverages business and, as a result of this agreement, Australia Beverages was treated as a discontinued operation in the presentation of the results for 2008. Subsequent to the balance sheet date, on 12 March 2009, the Group entered into a defi nitive sale and purchase agreement for the sale of the Australia Beverages business to Asahi for a total consideration in cash of approximately 550m (AUDI, 185m). The agreement with Asahi is subject to normal closing conditions, which do not include fi nancing or competition authority clearance conditions, and the Group expects that the pre-conditions to closing will have been satisfi ed by 30 April 2009. should treat costs directly associated with revenues (product costs, such as materials, labor and related fringe benefits, and manufacturing overhead) in the same manner for interim reports as for annual reports. Companies should use the same inventory pricing methods (FIFO, average cost, etc.) for interim reports and for annual reports. However, companies may use the gross profit method for interim inventory pricing. But, they must disclose the method and adjustments to reconcile with annual inventory. Discrete Approach. Following the discrete approach, companies record in interim reports revenues and expenses according to the revenue and expense recognition principles. This includes costs and expenses other than product costs (often referred to as period costs). No accruals or deferrals in anticipation of future events during the year should be reported. For example, the cost of a planned major periodic maintenance or overhaul for a company like Airbus or other seasonal expenditure that is expected to occur late in the year is not anticipated for interim reporting purposes. The mere intention or necessity to incur expenditure related to the future is not sufficient to give rise to an obligation. Or, a company like Carrefour may budget certain costs expected to be incurred irregularly during the financial year, such as advertising and employee training costs. Those costs generally are discretionary even though they are planned and tend to recur from year to year. However, recognizing an obligation at the end of an interim financial reporting period for such costs that have not yet been incurred generally is not consistent with the definition of a liability. While year-to-date measurements may involve changes in estimates of amounts reported in prior interim periods of the current financial year, the principles for recognizing assets, liabilities, income, and expenses for interim periods are the same as in annual financial statements. For example, Wm Morrison Supermarkets plc records losses from inventory write-downs, restructurings, or impairments in an interim period similar to how it would treat these items in the annual financial statements (when incurred). However, if an estimate from a prior interim period changes in a subsequent interim period of that year, the original estimate is adjusted in the subsequent interim period. Interim Disclosures. IFRS does not require a complete set of financial statements at the interim reporting date. Rather, companies may comply with the requirements by providing condensed financial statements and selected explanatory notes. Because users of interim financial reports also have access to the most recent annual financial report, companies only need provide explanation of significant events and transactions since the end of the last annual reporting period. Companies should report the following interim data at a minimum. 1. Statement that the same accounting policies and methods of computation are followed in the interim fi nancial statements as compared with the most recent annual fi nancial statements or, if those policies or methods have been changed, a description of the nature and effect of the change. 2. Explanatory comments about the seasonality or cyclicality of interim operations. 3. The nature and amount of items affecting assets, liabilities, equity, net income, or cash fl ows that are unusual because of their nature, size, or incidence. 4. The nature and amount of changes in accounting policies and estimates of amounts previously reported. 5. Issuances, repurchases, and repayments of debt and equity securities. 6. Dividends paid (aggregate or per share) separately for ordinary shares and other shares. IFRS Insights 1577 7. Segment information, as required by IFRS 8, “Operating Segments.” 8. Changes in contingent liabilities or contingent assets since the end of the last annual reporting period. 9. Effect of changes in the composition of the company during the interim period, such as business combinations, obtaining or losing control of subsidiaries and long-term investments, restructurings, and discontinued operations. 10. Other material events subsequent to the end of the interim period that have not been refl ected in the fi nancial statements for the interim period. If a complete set of financial statements is provided in the interim report, companies comply with the provisions of IAS 1, “Presentation of Financial Statements.”
ON THE HORIZON
Sir David Tweedie, chair of the IASB, recently stated, “By 2011–2012, U.S. and international accounting should be pretty much the same.” There is no question that IFRS and GAAP are converging quickly. We have provided expanded discussion in the International Perspectives and IFRS Insights to help you understand the issues surrounding convergence as they relate to intermediate accounting. After reading these discussions, you should realize that IFRS and GAAP are very similar in many areas, with differences in those areas revolving around some minor technical points. In other situations, the differences are major; for example, IFRS does not permit LIFO inventory accounting. Our hope is that the FASB and IASB can quickly complete their convergence efforts, resulting in a single set of high-quality accounting standards for use by companies around the world.
IFRS SELF-TEST QUESTIONS
1. Which of the following is false? (a) In general, IFRS note disclosures are more expansive compared to GAAP. (b) GAAP and IFRS have similar standards on subsequent events. (c) Both IFRS and GAAP require interim reports although the reporting frequency varies. (d) Segment reporting requirements are very similar under IFRS and GAAP. 2. Differential reporting for small- and medium-sized entities: (a) is required for all companies less than a certain size. (b) omits accounting topics not relevant for SMEs, such as earnings per share, and interim and segment reporting. (c) has different rules for topics such as earnings per share, and interim and segment reporting. (d) requires signifi cantly more disclosures, since more items are not recognized in the fi nancial statements. 3. Subsequent events are reviewed through which date under IFRS? (a) Statement of fi nancial position date. (b) Sixty days after the year-end date. (c) Date of independent auditor’s opinion. (d) Authorization date of the fi nancial statements. 4. Under IFRS, share dividends declared after the statement of fi nancial position date but before the end of the subsequent events period are: (a) accounted for similar to errors as a prior period adjustment. (b) adjusted subsequent events, because they are paid from prior year earnings. (c) not adjusted in the current year’s fi nancial statements. (d) recognized on a prospective basis from the date of declaration. 5. Interim reporting under IFRS: (a) is prepared using the discrete approach. (b) is prepared using a combination of the discrete and integral approach. (c) requires a complete set of fi nancial statements for each interim period. (d) permits companies to omit disclosure of material events subsequent to the interim reporting date.
IFRS CONCEPTS AND APPLICATION

IFRS24-1
Where can authoritative IFRS be found related to the various disclosure issues discussed in the chapter?
IFRS24-2
What are the major types of subsequent events? Indicate how each of the following “subsequent events” would be reported. (a) Collection of a note written off in a prior period. (b) Issuance of a large preference share offering. (c) Acquisition of a company in a different industry. (d) Destruction of a major plant in a fl ood. (e) Death of the company’s chief executive offi cer (CEO). (f) Additional wage costs associated with settlement of a four-week strike. (g) Settlement of an income tax case at considerably more tax than anticipated at year-end. (h) Change in the product mix from consumer goods to industrial goods.
IFRS24-3
Morlan Corporation is preparing its December 31, 2012, financial statements. Two events that occurred between December 31, 2012, and March 10, 2013, when the statements were authorized for issue, are described below. 1. A liability, estimated at $160,000 at December 31, 2012, was settled on February 26, 2013, at $170,000. 2. A fl ood loss of $80,000 occurred on March 1, 2013.
Instructions
What effect do these subsequent events have on 2012 net income?
IFRS24-4
Keystone Corporation’s financial statements for the year ended December 31, 2012, were authorized for issue on March 10, 2013. The following events took place early in 2013. (a) On January 10, 10,000 ordinary shares of $5 par value were issued at $66 per share. (b) On March 1, Keystone determined after negotiations with the taxing authorities that income taxes payable for 2012 should be $1,320,000. At December 31, 2012, income taxes payable were recorded at $1,100,000.
Instructions
Discuss how the preceding subsequent events should be reflected in the 2012 financial statements.
IFRS24-5 (Subsequent Events)
For each of the following subsequent events, indicate whether a company should (a) adjust the financial statements, (b) disclose in notes to the financial statements, or (c) neither adjust nor disclose. ______ 1. Settlement of a tax case at a cost considerably in excess of the amount expected at year-end. ______ 2. Introduction of a new product line. ______ 3. Loss of assembly plant due to fi re. IFRS Insights 1579 ______ 4. Sale of a signifi cant portion of the company’s assets. ______ 5. Retirement of the company president. ______ 6. Issuance of a signifi cant number of ordinary shares. ______ 7. Loss of a signifi cant customer. ______ 8. Prolonged employee strike. ______ 9. Material loss on a year-end receivable because of a customer’s bankruptcy. ______ 10. Hiring of a new president. ______ 11. Settlement of prior year’s litigation against the company. ______ 12. Merger with another company of comparable size.
IFRS24-6
What are interim reports? Why is a complete set of financial statements often not provided with interim data? What are the accounting problems related to the presentation of interim data?
IFRS24-7
Dierdorf Inc., a closely held corporation, has decided to go public. The controller, Ed Floyd, is concerned with presenting interim data when an inventory writedown is recorded. What problems are encountered with inventories when quarterly data are presented?
IFRS24-8
Bill Novak is working on an audit of an IFRS client. In his review of the client’s interim reports, he notes that the reports are prepared on a discrete basis. That is, each interim report is viewed as a distinct period. Is this acceptable under IFRS? If so, explain how that treatment could affect comparisons to a GAAP company.
IFRS24-9
Snider Corporation, a publicly traded company, is preparing the interim financial data which it will issue to its shareholders at the end of the first quarter of the 2012–2013 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 fi nancial statements in accordance with IFRS regarding interim fi nancial 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 fi xed selling expenses would be refl ected in Snider Corporation’s quarterly report prepared for the fi rst quarter of the 2012–2013 fi scal year. Briefl y justify your presentation. (b) What fi nancial information, as a minimum, must Snider Corporation disclose to its shareholders in its quarterly reports?
Professional Research

IFRS24-10
As part of the year-end audit, you are discussing the disclosure checklist with your client. The checklist identifies the items that must be disclosed in a set of IFRS financial statements. The client is surprised by the disclosure item related to accounting policies. Specifically, since the audit report will attest to the statements being prepared in accordance with IFRS, the client questions the accounting policy checklist item. The client has asked you to conduct some research to verify the accounting policy disclosures.
Instructions
Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/ ). When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following questions. (Provide paragraph citations.) (a) In general, what should disclosures of accounting policies encompass? (b) List some examples of the most commonly required disclosures.
International Financial Reporting Problem:

Marks and Spencer plc

IFRS24-11
The financial statements of Marks and Spencer plc (M&S) are available at the book’s companion website or can be accessed at http://corporate.marksandspencer. com/documents/publications/2010/Annual_Report_2010.
Instructions
Refer to M&S’s financial statements and the accompanying notes to answer the following questions. (a) What specifi c items does M&S discuss in its Note 1—Summary of Signifi cant Accounting Policies? (List the headings only.) (b) For what segments did M&S report segmented information? Which segment is the largest? Who is M&S’s largest customer? (c) What interim information was reported by M&S?
ANSWERS TO IFRS SELF-TEST QUESTIONS
1. c 2. b 3. d 4. c 5. a





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