Radiohead Inc., a private company following ASPE, produces electronic components for sale to manufacturers of radios, television sets, and digital sound systems. In connection with her examination of Radiohead’s financial statements for the year ended December 31, 2023, Marg Zajic, CPA, completed fieldwork two weeks ago. Marg is now evaluating the significance of the following items before preparing her auditor’s report. Except as noted, none of these items has been disclosed in the financial statements or notes.

Item 1
A 10-year loan agreement that the company entered into three years ago provides that, subsequent to the date of the agreement, dividend payments may not exceed net income earned. The balance of retained earnings at the date of the loan agreement was $420,000. From that date through December 31, 2023, net income has totalled $570,000 and cash dividends have totalled $320,000. Based on these data, the staff auditor who was assigned to this review concluded that there was no retained earnings restriction at December 31, 2023.

Item 2
Recently, Radiohead interrupted its policy of paying cash dividends quarterly to its shareholders. Dividends were paid regularly through 2022, discontinued for all of 2023 to finance the purchase of equipment for the company’s new plant, and resumed in the first quarter of 2024. In the annual report, dividend policy is to be discussed in the president’s letter to shareholders.

Item 3
A large competitor has introduced a line of products that will compete directly with Radiohead’s most important products, which are now being produced in Radiohead’s specially designed new plant. Because of a new manufacturing process, the competitor’s line will be of similar quality but will be priced at a major discount relative to Radiohead’s line. The competitor announced its new line during the week following the completion of Marg’s fieldwork. Marg read the announcement in the newspaper and discussed the situation by telephone with Radiohead executives. Radiohead plans to match the lower prices because they are still high enough to cover variable manufacturing and selling expenses. However, now fixed costs will not be fully recovered.

Item 4
Radiohead operates in a new manufacturing plant, which cost $2.4 million and has an estimated life of 25 years. It is leased from ANS Tooling Inc. at an annual rental of $600,000 on the first day of each year of the lease. The market rate of interest is 9% and the fair value of the building at the inception of the lease is $4.2 million. Radiohead is obligated to pay property tax, insurance, and maintenance. At the end of its 10-year non-cancellable lease, Radiohead has the option of purchasing the property for $1. In Radiohead’s income statement, the rent expense is reported on a separate line.

Instructions
For each of the items, discuss any additional disclosures in the financial statements and notes that the auditor should recommend to her client. (Do not consider the cumulative effect of the four items.)