Action Items
- States the identified accounting issue.
- Identifies the accounting rule(s) that pertain to the issue.
- Explain the accounting rule(s) and treatment of the issue.
- Issue: Succinctly state the accounting issue.
- Rule: Using your research of authoritative accounting sources, briefly identify and explain the authoritative rule.
- Analysis: Apply the facts of the case study to the rule and provide an in-depth analysis based on the issue. Your analysis should include supporting schedules, calculations, and correcting journal entries.
- Conclusion: based on the results of your analysis and indicate any changes to the financial statements and disclosure notes resulting from the rule.
HYDROQUAL, INC. Preliminary Financials 20X4 It was a pretty autumn day in late October 20X4. Tom Fasbee had just returned from vacation. He was getting caught up on the many matters that no one else had handled while he was gone. Near the middle of a stack of messages, he found a note from Rick Bailey requesting an appointment with Tom and you. Tom arranged a meeting with Rick, Kay, Jerry, and you for 2:00 P.M. the next day at HydroQual. Once the meeting began, Rick reminded Tom of a pickleball engagement and then got down to business. First, Rick noted that maintenance work and merchandise sales were going like "gangbusters." To meet demand, HydroQual now was running two crews at night and had also begun selling inventory parts separate from the maintenance work. Tom asked what steps had been taken to expand their customer base. Kay replied that HydroQual had acquired a 20 percent interest in the small dealership, QUALPV, which carried their line of pumps and valves. Kay also had been appointed a member of QUALPV's board. This new investment would give HydroQual the opportunity to observe and learn the equipment supply business first hand. If things went well, HydroQual would later consider acquiring the remaining interest in the dealership. Kay indicated that HydroQual had paid more than book value for the stock because QUALPV owned an important patent that had been developed internally that was not included in their financial statements. The patent has a remaining life of 4 years. You also learned later from Martha Mason that the equity method of accounting was not allowed for tax purposes. For tax purposes, such investments were recorded at cost, and the only income reported came from dividends. Martha Mason also revealed that when equity ownership equals 20 percent or more, the dividends received deduction is 65 percent rather than 50 percent. Rick then stated that because they had the expertise in-house, the Company had decided to take on the construction of a water treatment plant for a small town nearby. As it happened, a warehouse had come up for sale just a block away from the shop, and although it was larger than what they needed to house the inventory items, the extra space was perfect for setting up the facility needed to support construction projects. The warehouse was purchased on March 15,20X4. All equipment needed to move and store the inventory and to perform the work related to the construction of the water treatment plant was purchased and put into use on the same date. The financing for these investments was provided in part by a local investor who had been Rick's college roommate and was a trusted friend. He has been so impressed by the growth and potential of HydroQual, that he was eager to negotiate a convertible bond, with the idea of becoming an owner in the future if the company continued on its current path. The bond was set up with the same covenants that the Bank had required on the note, and also required that the annual financial statements would be audited instead of reviewed as in the first three years. The bond was set up to convert to 3,000 shares of common stock any time during the five year term. Jerry hoped that Dunes \& Driftwood would accept the engagement and that you would conduct the audit. Although the thought of one more time crossed your mind, the engagement was accepted. In parting, you asked Jerry to furnish 20X4 financial statements in early January. Because of the large increase in the pump and valve inventory levels, you also requested that Dunes \& Driftwood be involved with the year-end physical inventory. This prompted Jerry to ask whether expanding the line of merchandise and doing construction would put HydroQual in two or three lines of business and whether this would impact the financial statements. You observed the physical inventory in late December and found that the construction job was well underway. On January 16, 20X5, Jerry sent you copies of the financial statements and related schedules, and a pre-audit meeting was scheduled for January 19. REQUIRED: The journal entries and financial statements prepared by Jerry Loos are attached. Review these data and prepare a list of additional information needed from Jerry. Be as specific as possible and phrase your requests in the form of questions as they normally would be asked of a client. You should also be prepared to explain your reasons for asking specific questions. Once again, Jerry has asked you to prepare the statement of cash flows, statement of changes in stockholders' equity, financial statement notes, and earnings per share disclosures once the audit is complete. He also reminded you that the Bank wants comparative statements and requires the fair value of all financial instruments and information on major customers be disclosed. HYDROQUAL, INC. BALANCE SHEET DECEMBER 31, 20X4 ASSETS CURRENT ASSETS Cash Accounts receivable PROPERTY, PLANT, AND EQUIPMENT Land Equipment Accumulated depreciation--equipment Vehicles Accumulated depreciation--vehicles Warehouse Accumulated depreciation--warehouse Total Property, Plant, and Equipment (11,250)835,728 RIGHT OF USE ASSETS Operating lease-equipment Operating lease-building Finance lease-trucks Total Right of Use Assets 81,400317,593 INTANGIBLE ASSETS License agreement Total Intangible Assets 33,00033,000 OTHER ASSETS Marketable equity investment AFS bond investment Long-term investment Deferred income tax Total Other Assets TOTAL ASSETS $3,131,040 VDIAI INIC HYDROQUAL, INC. HYDROQUAL, INC. JOURNAL ENTRIES DECEMBER 31, 20X4 HYDROQUAL, INC. Preliminary Financials 20X4 It was a pretty autumn day in late October 20X4. Tom Fasbee had just returned from vacation. He was getting caught up on the many matters that no one else had handled while he was gone. Near the middle of a stack of messages, he found a note from Rick Bailey requesting an appointment with Tom and you. Tom arranged a meeting with Rick, Kay, Jerry, and you for 2:00 P.M. the next day at HydroQual. Once the meeting began, Rick reminded Tom of a pickleball engagement and then got down to business. First, Rick noted that maintenance work and merchandise sales were going like "gangbusters." To meet demand, HydroQual now was running two crews at night and had also begun selling inventory parts separate from the maintenance work. Tom asked what steps had been taken to expand their customer base. Kay replied that HydroQual had acquired a 20 percent interest in the small dealership, QUALPV, which carried their line of pumps and valves. Kay also had been appointed a member of QUALPV's board. This new investment would give HydroQual the opportunity to observe and learn the equipment supply business first hand. If things went well, HydroQual would later consider acquiring the remaining interest in the dealership. Kay indicated that HydroQual had paid more than book value for the stock because QUALPV owned an important patent that had been developed internally that was not included in their financial statements. The patent has a remaining life of 4 years. You also learned later from Martha Mason that the equity method of accounting was not allowed for tax purposes. For tax purposes, such investments were recorded at cost, and the only income reported came from dividends. Martha Mason also revealed that when equity ownership equals 20 percent or more, the dividends received deduction is 65 percent rather than 50 percent. Rick then stated that because they had the expertise in-house, the Company had decided to take on the construction of a water treatment plant for a small town nearby. As it happened, a warehouse had come up for sale just a block away from the shop, and although it was larger than what they needed to house the inventory items, the extra space was perfect for setting up the facility needed to support construction projects. The warehouse was purchased on March 15,20X4. All equipment needed to move and store the inventory and to perform the work related to the construction of the water treatment plant was purchased and put into use on the same date. The financing for these investments was provided in part by a local investor who had been Rick's college roommate and was a trusted friend. He has been so impressed by the growth and potential of HydroQual, that he was eager to negotiate a convertible bond, with the idea of becoming an owner in the future if the company continued on its current path. The bond was set up with the same covenants that the Bank had required on the note, and also required that the annual financial statements would be audited instead of reviewed as in the first three years. The bond was set up to convert to 3,000 shares of common stock any time during the five year term. Jerry hoped that Dunes \& Driftwood would accept the engagement and that you would conduct the audit. Although the thought of one more time crossed your mind, the engagement was accepted. In parting, you asked Jerry to furnish 20X4 financial statements in early January. Because of the large increase in the pump and valve inventory levels, you also requested that Dunes \& Driftwood be involved with the year-end physical inventory. This prompted Jerry to ask whether expanding the line of merchandise and doing construction would put HydroQual in two or three lines of business and whether this would impact the financial statements. You observed the physical inventory in late December and found that the construction job was well underway. On January 16, 20X5, Jerry sent you copies of the financial statements and related schedules, and a pre-audit meeting was scheduled for January 19. REQUIRED: The journal entries and financial statements prepared by Jerry Loos are attached. Review these data and prepare a list of additional information needed from Jerry. Be as specific as possible and phrase your requests in the form of questions as they normally would be asked of a client. You should also be prepared to explain your reasons for asking specific questions. Once again, Jerry has asked you to prepare the statement of cash flows, statement of changes in stockholders' equity, financial statement notes, and earnings per share disclosures once the audit is complete. He also reminded you that the Bank wants comparative statements and requires the fair value of all financial instruments and information on major customers be disclosed. HYDROQUAL, INC. BALANCE SHEET DECEMBER 31, 20X4 ASSETS CURRENT ASSETS Cash Accounts receivable PROPERTY, PLANT, AND EQUIPMENT Land Equipment Accumulated depreciation--equipment Vehicles Accumulated depreciation--vehicles Warehouse Accumulated depreciation--warehouse Total Property, Plant, and Equipment (11,250)835,728 RIGHT OF USE ASSETS Operating lease-equipment Operating lease-building Finance lease-trucks Total Right of Use Assets 81,400317,593 INTANGIBLE ASSETS License agreement Total Intangible Assets 33,00033,000 OTHER ASSETS Marketable equity investment AFS bond investment Long-term investment Deferred income tax Total Other Assets TOTAL ASSETS $3,131,040 VDIAI INIC HYDROQUAL, INC. HYDROQUAL, INC. JOURNAL ENTRIES DECEMBER 31, 20X4
