Question & Answer

FIFO, average-cost, and LIFO methods are often used instead of specific identification for inventory valuation purposes. Compare these methods with the specific identification method, discussing the theoretical propriety of each method in the determination of income and asset valuation.

Specific identification is sometimes said to be the ideal method of assigning cost to inventory and to cost of goods sold. Briefly indicate the arguments for and against this method of inventory valuation.

Zonker Inc. purchases 500 units of an item at an invoice cost of $30,000. What is the cost per unit? If the goods are shipped f.o.b. shipping point and the freight bill was $1,500, what is the cost per unit if Zonker Inc. pays the freight charges? If these items were bought on 2/10, n/30 terms and the invoice and the freight bill were paid within the 10-day period, what would be the cost per unit?

Ford Motor Co. is considering alternate methods of accounting for the cash discounts it takes when paying suppliers promptly. One method suggested was to report these discounts as financial income when payments are made. Comment on the propriety of this approach.

Distinguish between product costs and period costs as they relate to inventory

Define “cost” as applied to the valuation of inventories.

At the balance sheet date, Clarkson Company held title to goods in transit amounting to $214,000. This amount was omitted from the purchases figure for the year and also from the ending inventory. What is the effect of this omission on the net income for the year as calculated when the books are closed? What is the effect on the company’s financial position as shown in its balance sheet? Is materiality a factor in determining whether an adjustment for this item should be made?

Where, if at all, should the following items be classified on a balance sheet?

(a) Goods out on approval to customers.

(b) Goods in transit that were recently purchased f.o.b. destination.

(c) Land held by a realty firm for sale.

(d) Raw materials.

(e) Goods received on consignment.

(f) Manufacturing supplies.

What is a product financing arrangement? How should product financing arrangements be reported in the financial statements?

Mishima, Inc. indicated in a recent annual report that approximately $19 million of merchandise was received on consignment. Should Mishima, Inc. report this amount on its balance sheet? Explain.

What is the difference between a perpetual inventory and a physical inventory? If a company maintains a perpetual inventory, should its physical inventory at any date be equal to the amount indicated by the perpetual inventory records? Why?

Why should inventories be included in (a) a statement of financial position and (b) the computation of net income?

In what ways are the inventory accounts of a retailing company different from those of a manufacturing company?

Microsoft is the leading developer of software in the world. To continue to be successful Microsoft must generate new products, which requires significant amounts of cash. The following is the current asset and current liability information from Microsoft’s current balance sheets (in millions). Following the Microsoft data is the current asset and current liability information from Oracle’s current balance sheets (in millions). Oracle is another major software developer.

Part 1 (Cash and Cash Equivalents)

Instructions

(a) What is the definition of a cash equivalent? Give some examples of cash equivalents. How do cash equivalents differ from other types of short-term investments?

(b) Calculate (1) the current ratio and (2) working capital for each company for 2011 and discuss your results.

(c) Is it possible to have too many liquid assets?

Part 2 (Accounts Receivable)

Microsoft provided the following disclosure related to its accounts receivable.

Instructions

(a) Compute Microsoft’s accounts receivable turnover for 2011 and discuss your results. Microsoft had sales revenue of $69,943 million in 2011.

(b) Reconstruct the summary journal entries for 2011 based on the information in the disclosure.

(c) Briefly discuss how the accounting for bad debts affects the analysis in Part 2 (a).

Occidental Petroleum Corporation reported the following information in a recent annual report.

Instructions

(a) What items other than coin and currency may be included in “cash”?

(b) What items may be included in “cash equivalents”?

(c) What are compensating balance arrangements, and how should they be reported in financial statements?

(d) What are the possible differences between cash equivalents and short-term (temporary) investments?

(e) Assuming that the sale agreement meets the criteria for sale accounting, cash proceeds were

$345 million, the carrying value of the receivables sold was $360 million, and the fair value of the recourse liability was $15 million, what was the effect on income from the sale of receivables?

(f) Briefly discuss the impact of the transaction in (e) on Occidental’s liquidity.

As the new staff person in your company’s treasury department, you have been asked to conduct research related to a proposed transfer of receivables. Your supervisor wants the authoritative sources for the following items that are discussed in the receivables transfer agreement.

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 prepare responses to the following items. (a) Identify relevant IFRSs that address transfers of receivables. (b) What are the objectives for reporting transfers of receivables?

(c) Provide the definition for “Amortized cost.”

On December 31, 2014, Firth Company borrowed $62,092 from Paris Bank, signing a 5-year, $100,000 zero-interest-rate note. The note was issued to yield 10% interest. Unfortunately, during 2016,

Firth began to experience financial difficulty. As a result, at December 31, 2016, Paris Bank determined that it was probable that it would collect only $75,000 at maturity. The market rate of interest on loans of this nature is now 11%.

Instructions

(a) Prepare the entry (if any) to record the impairment of the loan on December 31, 2016, by Paris Bank.

(b) Prepare the entry on March 31, 2017, if Paris learns that Firth will be able to repay the loan under the original terms.

What are some steps taken by both the FASB and IASB to move to fair value measurement for financial instruments? In what ways have some of the approaches differed?

Briefly describe the impairment evaluation process and assessment of receivables on an individual or collective basis.

As the new staff person in your company’s treasury department, you have been asked to conduct research related to a proposed transfer of receivables. Your supervisor wants the authoritative sources for the following items that are discussed in the securitization agreement.

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) Identify relevant Codification section that addresses transfers of receivables.

(b) What are the objectives for reporting transfers of receivables?

(c) Provide definitions for the following:

(1) Transfer.

(2) Recourse.

(3) Collateral.

(d) Provide other examples (besides recourse and collateral) that qualify as continuing involvement.

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 criteria does P&G use to classify “Cash and cash equivalents” as reported in its balance sheet?

(b) As of June 30, 2011, what balances did P&G have in cash and cash equivalents? What were the major uses of cash during the year?

(c) P&G reports no allowance for doubtful accounts, suggesting that bad debt expense is not material for this company. Is it reasonable that a company like P&G would not have material bad debt expense? Explain.

Marvin Company is a subsidiary of Hughes Corp. The controller believes that the yearly allowance for doubtful accounts for Marvin should be 2% of net credit sales. Given the recession and the high interest rate environment, the president, nervous that the parent company might expect the subsidiary to sustain its 10% growth rate, suggests that the controller increase the allowance for doubtful accounts to 3% yearly. The president thinks that the lower net income, which reflects a 6% growth rate, will be a more sustainable rate for Marvin Company.

Instructions

(a) In a recessionary environment with tight credit and high interest rates:

(1) Identify steps Marvin Company might consider to improve the accounts receivable situation.

(2) Then evaluate each step identified in terms of the risks and costs involved.

(b) Should the controller be concerned with Marvin Company’s growth rate in estimating the allowance?

Explain your answer.

(c) Does the president’s request pose an ethical dilemma for the controller? Give your reasons.

As the manager of the accounts receivable department for Beavis Leather Goods, Ltd., you recently noticed that Kelly Collins, your accounts receivable clerk who is paid $1,200 per month, has been wearing unusually tasteful and expensive clothing. (This is Beavis’s first year in business.) This morning, Collins drove up to work in a brand new Lexus.

Naturally suspicious by nature, you decide to test the accuracy of the accounts receivable balance of $192,000 as shown in the ledger. The following information is available for your first year (precisely

9 months ended September 30, 2014) in business.

(1) Collections from customers $188,000

(2) Merchandise purchased 360,000

(3) Ending merchandise inventory 90,000

(4) Goods are marked to sell at 40% above cost.

Instructions

Assuming all sales were made on account, compute the ending accounts receivable balance that should appear in the ledger, noting any apparent shortage. Then, draft a memo dated October 3, 2014, to Mark Price, the branch manager, explaining the facts in this situation. Remember that this problem is serious, and you do not want to make hasty accusations.

Soon after beginning the year-end audit work on March 10 at Engone Company, the auditor has the following conversation with the controller. Controller: The year ended March 31st should be our most profitable in history and, as a consequence, the board of directors has just awarded the officers generous bonuses. Auditor: I thought profits were down this year in the industry, according to your latest interim report. Controller: Well, they were down, but 10 days ago we closed a deal that will give us a substantial increase for the year.

Auditor: Oh, what was it?

Controller: Well, you remember a few years ago our former president bought stock in Henderson Enterprises because he had those grandiose ideas about becoming a conglomerate. For 6 years we have not been able to sell this stock, which cost us $3,000,000 and has not paid a nickel in dividends. Thursday we sold this stock to Bimini Inc. for $4,000,000. So, we will have a gain of $700,000 ($1,000,000 pretax) which will increase our net income for the year to $4,000,000, compared with last year’s $3,800,000. As far as I know, we’ll be the only company in the industry to register an increase in net income this year. That should help the market value of the stock!

Auditor: Do you expect to receive the $4,000,000 in cash by March 31st, your fiscal year-end?

Controller: No. Although Bimini Inc. is an excellent company, they are a little tight for cash because of their rapid growth. Consequently, they are going to give us a $4,000,000 zero-interestbearing note with payments of $400,000 per year for the next 10 years. The first payment is due on March 31 of next year.

Auditor: Why is the note zero-interest-bearing?

Controller: Because that’s what everybody agreed to. Since we don’t have any interest-bearing debt, the funds invested in the note do not cost us anything and besides, we were not getting any dividends on the Henderson Enterprises stock.

Instructions

Do you agree with the way the controller has accounted for the transaction? If not, how should the transaction be accounted for?