CHAPTER 6

Cases

Solution to Judgment Case 1: Balance Sheet Management

1. If management makes the most conservative choices then assets and liabilities will be impacted as follows:

Adjustment	Impact on Total Assets	Impact on Total Liabilities	Current or Non-Current?
1. Bad Debt Expense
2. Inventory Write Down
3. Impairment of PPE
4. Impairment of Noncurrent Investments
5. Contingency -Current
6. Valuation Allowance
7. Revenue Recognition
Total Dollar Impact
As Originally Reported	$177,100	$111,100
Percentage Change

293 Statements of Financial Position and Cash Flows and the Annual Report Judgment Cases CASES Judgment Case 1: Balance Sheet Management The CFO of First Things Computing, Inc. (FTC) prepared the following balance sheet as of December 31,2019 First Things Computing, Inc. Balance Sheet As of December 31, 2019 Assets Current Assets: $ 5,000 Cash Trading Securities at Fair Value 700 11,000 24,000 Accounts Receivable- net Merchandise Inventory Office Supplies 600 Prepaid Rent 200 $ 41,500 Total Current Assets Noncurrent Assets: Investments $15,000 Property, Plant, and Equipment Land 20,000 Buildings 80,000 Machinery and Equipment Less: Accumulated Depreciation 70,000 (62,000) Total Property, Plant, and Equipment -net 108,000 Deferred Tax Asset 5,000 Intangible Assets: Franchise -net 4,500 3,100 Other Assets $135,600 $ 177,100 Total Noncurrent Assets Total Assets Liabilities Current Liabilities $ 2,700 1,000 Accounts Payable Short-term Notes Payable Current Portion of Long-term Debt Interest Payable 300 200 Income Taxes Payable 1,500 5,400 $ 11,100 Uneaned Revenue Total Current Liabilities Noncurrent Liabilities: $ 40,000 Notes Payable, due 10 years Bonds Payable, due 20 years 60,000 100,000 $ 11,100 Total Noncurrent Liabilities Total Liabilities Stockholders' Equity $ 20,000 30,000 5,000 Common Stock- at par Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Income 11,000 Total Stockholders' Equity $66,000 Total Liabilities and Stockholders' Equity $177,100 For the sake of simplicity, assume that FTC does not incur income tax expense. Thus, the impact on equity can be computed as the combination of the impact on assets and the impact on the liabilities The CFO must make the following adjustments before finalizing the financial statements: 1. FTC will need to record some amount of bad debt expense. The offset will be a reduction in accounts receivable. This adjustment is a matter of judgment, and reasonable estimates range between S1,000 and $3,000 2. FTC will need to write down its inventory (ie., reduce the reported value of inventory). The offset will be to cost of goods sold. This adjustment is a matter of judgment, and reasonable estimates range between $2,500 and $3,750. 3. FTC may need to record an impairment loss on its PPE (i.e., reduce the reported value of PPE). The offset will be an impairment loss reported on the statement of net income. This adjustment is a matter of judgment, and reasonable estimates range between S0 and $5,000. 4. FTC may need to record an impairment loss on its noncurrent investments (i.e., reduce the reported value of noncurrent investments). The offset will be an impaiment loss reported on the statement of net income. This adjustment is a matter of judgment, and reasonable estimates range between $250 and $750. 5. FTC may need to record a litigation contingency (i.e., it may need to record a liability for an unresolved lawsuit). The offset is to litigation expense. The lawsuit is expected to be settled in 2020. FTC's attor neys believe that they can provide a point estimate of amount for which FTC will be liable. The estimate will either be $2,000 or $i0,000. 6. FTC may need to reduce the reported amount of its deferred tax asset. The amount by which the asset needs to be reduced is highly judgmental and ranges from $0 to $5,000. The offset to this adjustment is income tax expense. Assume the deferred tax asset is noncurrent 7. FTC currently has unearned revenue on its balance sheet of $5,400. Up to $5,000 of this amount could possibly be recognized as revenue in 2019. However, this amount is a matter of judgment. Required a. If FTC makes the most conservative choices for all these adjustments that will result in the lowest net income number, what is the impact on assets and liabilities in terms of absolute dollar impact and percentage change? b. If FTC makes the least conservative choices for all these adjustments that will result in the highest net income number, what is the impact on assets and liabilities in terms of absolute dollar impact and percentage change? c. What is the impact on the current ratio and the debt-to-equity ratio of these choices if management makes the most conservative choices? What is the impact on these ratios if management makes the least conservative choices? d. Do you think that the management of FTC will care very much about the choices related to these adjustments? 293 Statements of Financial Position and Cash Flows and the Annual Report Judgment Cases CASES Judgment Case 1: Balance Sheet Management The CFO of First Things Computing, Inc. (FTC) prepared the following balance sheet as of December 31,2019 First Things Computing, Inc. Balance Sheet As of December 31, 2019 Assets Current Assets: $ 5,000 Cash Trading Securities at Fair Value 700 11,000 24,000 Accounts Receivable- net Merchandise Inventory Office Supplies 600 Prepaid Rent 200 $ 41,500 Total Current Assets Noncurrent Assets: Investments $15,000 Property, Plant, and Equipment Land 20,000 Buildings 80,000 Machinery and Equipment Less: Accumulated Depreciation 70,000 (62,000) Total Property, Plant, and Equipment -net 108,000 Deferred Tax Asset 5,000 Intangible Assets: Franchise -net 4,500 3,100 Other Assets $135,600 $ 177,100 Total Noncurrent Assets Total Assets Liabilities Current Liabilities $ 2,700 1,000 Accounts Payable Short-term Notes Payable Current Portion of Long-term Debt Interest Payable 300 200 Income Taxes Payable 1,500 5,400 $ 11,100 Uneaned Revenue Total Current Liabilities Noncurrent Liabilities: $ 40,000 Notes Payable, due 10 years Bonds Payable, due 20 years 60,000 100,000 $ 11,100 Total Noncurrent Liabilities Total Liabilities Stockholders' Equity $ 20,000 30,000 5,000 Common Stock- at par Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Income 11,000 Total Stockholders' Equity $66,000 Total Liabilities and Stockholders' Equity $177,100 For the sake of simplicity, assume that FTC does not incur income tax expense. Thus, the impact on equity can be computed as the combination of the impact on assets and the impact on the liabilities The CFO must make the following adjustments before finalizing the financial statements: 1. FTC will need to record some amount of bad debt expense. The offset will be a reduction in accounts receivable. This adjustment is a matter of judgment, and reasonable estimates range between S1,000 and $3,000 2. FTC will need to write down its inventory (ie., reduce the reported value of inventory). The offset will be to cost of goods sold. This adjustment is a matter of judgment, and reasonable estimates range between $2,500 and $3,750. 3. FTC may need to record an impairment loss on its PPE (i.e., reduce the reported value of PPE). The offset will be an impairment loss reported on the statement of net income. This adjustment is a matter of judgment, and reasonable estimates range between S0 and $5,000. 4. FTC may need to record an impairment loss on its noncurrent investments (i.e., reduce the reported value of noncurrent investments). The offset will be an impaiment loss reported on the statement of net income. This adjustment is a matter of judgment, and reasonable estimates range between $250 and $750. 5. FTC may need to record a litigation contingency (i.e., it may need to record a liability for an unresolved lawsuit). The offset is to litigation expense. The lawsuit is expected to be settled in 2020. FTC's attor neys believe that they can provide a point estimate of amount for which FTC will be liable. The estimate will either be $2,000 or $i0,000. 6. FTC may need to reduce the reported amount of its deferred tax asset. The amount by which the asset needs to be reduced is highly judgmental and ranges from $0 to $5,000. The offset to this adjustment is income tax expense. Assume the deferred tax asset is noncurrent 7. FTC currently has unearned revenue on its balance sheet of $5,400. Up to $5,000 of this amount could possibly be recognized as revenue in 2019. However, this amount is a matter of judgment. Required a. If FTC makes the most conservative choices for all these adjustments that will result in the lowest net income number, what is the impact on assets and liabilities in terms of absolute dollar impact and percentage change? b. If FTC makes the least conservative choices for all these adjustments that will result in the highest net income number, what is the impact on assets and liabilities in terms of absolute dollar impact and percentage change? c. What is the impact on the current ratio and the debt-to-equity ratio of these choices if management makes the most conservative choices? What is the impact on these ratios if management makes the least conservative choices? d. Do you think that the management of FTC will care very much about the choices related to these adjustments