Kamloops Company is a grocery wholesaler and is planning to expand its operations. The company has asked the bank for a loan to finance the expansion. Alphonzo, the company's manager, has prepared the preliminary financial statements. The preliminary financial statements for the year ended December 31, 2017, reported the following:
Current assets............................................$120,000
Current liabilities...........................................80,000
Sales........................................................560,000
Cost of goods sold.......................................252,000
Total operating expenses.................................106,000
The bank has requested that Kamloops have an independent professional accountant review the statements. You have been asked to review the statements and during your review you have discovered the following:
1. Kamloops's supplier shipped $15,000 of merchandise inventory to Kamloops on December 31, 2017, FOB shipping point. Alphonzo indicated that he did not record the inventory for the year ended December 31, 2017, because it was not received until January 2, 2018.
2. Included in sales and accounts receivable was $8,400 for merchandise ordered by a customer that was packed and in the warehouse. The customer indicated that they might pick it up on January 10, 2018. The customer will pay for the merchandise within 30 days of pickup. The cost of the merchandise was $4,300 and was included in merchandise inventory because the merchandise was still in Kamloops's warehouse.
3. Kamloops offers its customers a full refund for merchandise returned within 15 days of purchase. Sales recorded from December 17 to December 31 were $26,000. Typically, about 5% of sales are returned. The returned goods are scrapped and not returned to merchandise inventory. Alphonzo said that customers had not returned any merchandise from the December 17 to December 31 sales by the company's year end. Any returns from these sales will be recorded in January when the merchandise is returned and the company knows the exact amount of the returns.
4. During the last week of December, the company had run a promotional campaign in the local newspaper. The cost of the campaign was $3,500. Alphonzo recorded it as a prepaid expense because he anticipates that January 2018 sales will be higher as a result of the campaign.
Instructions
(a) Explain how financial statements help the bank with its decision on whether or not to lend money to Kamloops.
(b) Explain why the bank has requested an independent review of the financial statements.
(c) Calculate the correct amounts for current assets, current liabilities, sales, cost of goods sold, and total operating expenses. Explain each of your corrections. Kamloops Company uses the earnings approach to recognize revenue.
TAKING IT FURTHER
Calculate the current ratio based on (a) the preliminary financial statements and (b) the corrected amounts. Is the current ratio based on the corrected amounts better or worse? Does there appear to be bias in the types of errors that were made? Explain