Question & Answer

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 as follows.

Instructions

(a) Calculate a new set of ratios for the fiscal year 2015 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.

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 specific items does Coca-Cola discuss in its Note 1—Accounting Policies? (Prepare a list of the headings only.)

(2) What specific items does PepsiCo discuss in its Note 2—Our Summary of Significant 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 2011.

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/). (Click on the IFRS tab and then register for free eIFRS access if necessary.) 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.

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 2014–2015 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 IFRS 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 2014–2015 fiscal year.

Briefly justify your presentation.

(b) What financial information, as a minimum, must Snider Corporation disclose to its shareholders in its quarterly reports?

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.

Dierdorf Inc., a closely held corporation, has decided to go public. The controller, Ed Floyd, is concerned with presenting interim data when an inventory write-down is recorded. What problems are encountered with inventories when quarterly data are presented?

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?

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 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 ordinary shares.

________ 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 (no loss was accrued).

_______ 12. Merger with another company of comparable size.

Keystone Corporation’s financial statements for the year ended December 31, 2014, were authorized for issue on March 10, 2015. The following events took place early in 2015.

(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 2014 should be $1,320,000. At December 31, 2014, income taxes payable were recorded at $1,100,000.

Instructions

Discuss how the preceding subsequent events should be reflected in the 2014 financial statements.

Morlan Corporation is preparing its December 31, 2014, financial statements. Two events that occurred between December 31, 2014, and March 10, 2015, when the statements were authorized for issue, are described below.

1. A liability, estimated at $160,000 at December 31, 2014, was settled on February 26, 2015, at $170,000.

2. A flood loss of $80,000 occurred on March 1, 2015.

Instructions

What effect do these subsequent events have on 2014 net income?

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 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 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.

Where can authoritative IFRS be found related to the various disclosure issues discussed in the chapter?

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.

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 presented in Appendix 5B. The company’s complete annual report, including the notes to the financial statements, 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?

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 2015 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 2015 net income.

(b) Decreased the corporation’s 2015 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 2015.

_____ 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 2012, 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.

In June 2014, 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, 2014) 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, 2015. 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 2015, ratios should be better.

Instructions

(a) What are the ethical issues involved?

(b) Should McElroy agree to the delay?

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 2014 and 2015. 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 2015. 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.”

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?

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.  n 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 on the next page 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.

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 2014–2015 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 2014–2015 fiscal year.

Briefly justify your presentation.

(b) What financial information, as a minimum, must Snider Corporation disclose to its stockholders in its quarterly reports?

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.

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?

You are compiling the consolidated financial statements for Winsor Corporation International. The corporation’s accountant, Anthony Reese, has provided you with the segment  shown on the next page.

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 2015, 2014, and

2013 follows. (thousands)

Funeral Floral Cemetery Real Estate Dried Whey Limousine Consolidated

Revenues

2015 $302,000 $10,000 $ 73,000 $ 2,000 $7,000 $12,000 $406,000

2014 245,000 6,000 61,000 4,000 4,000 4,000 324,000

2013 208,000 3,000 42,000 3,000 1,000 3,000 260,000

Operating Income

2015 74,000 1,500 18,000 (36,000) 500 2,000 60,000

2014 64,000 200 12,000 (28,000) 200 400 48,800

2013 54,000 150 6,000 (21,000) 100 350 39,600

Capital Expenditures

2015 26,000 1,000 9,000 400 300 1,000 37,700

2014 28,000 2,000 60,000 1,500 100 700 92,300

2013 14,000 25 8,000 600 25 50 22,700

Depreciation and Amortization

2015 13,000 100 2,400 1,400 100 200 17,200

2014 10,000 50 1,400 700 50 100 12,300

2013 8,000 25 1,000 600 25 50 9,700

Identifi able Assets

2015 334,000 1,500 162,000 114,000 500 8,000 620,000

2014 322,000 1,000 144,000 52,000 1,000 6,000 526,000

2013 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.

At December 31, 2014, 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 2014 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,

2015, and you find the following.

1. On February 3, 2015, one of Coburn’s customers declared bankruptcy. At December 31, 2014, this company owed Coburn $300,000, of which $60,000 was paid in January 2015.

2. On January 18, 2015, one of the three major plants of the client burned.

3. On January 23, 2015, 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, 2014. 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, 2015, 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, 2015, was on a lower-of-cost-or-market basis.

6. On February 1, 2015, 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 2014 financial statements would be affected, if at all.