Donavan Jewelers

Since you will be performing the first audit of our company for the calendar year 2022, I thought I would begin with some background information concerning our company:

1. Our company owns a single jewelry store in Fort Wayne, Indiana. We use a calendar year as our fiscal year. My wife, my three children and I own all of the outstanding stock of the corporation.
2. We use a periodic inventory system, but do not take a physical count of inventory at year end. We take our annual physical count of inventory in mid-February during the financial audit conducted by our CPA. We, therefore, have to estimate our ending inventory at year-end, which we do by using the gross-profit method.
3. We use the LIFO inventory valuation method for tax purposes to keep our tax liability as low as possible. During periods of high inflation, we use the FIFO inventory valuation for financial reporting purposes. During periods of moderate inflation, such as we have today, we use the LIFO inventory valuation method. We include in the capitalized cost of our ending merchandise inventory each year both an allocated portion of freight-in costs and an allocated portion of storage costs incurred to safeguard inventory between the time of purchase and the time of sale. The cost of inventory during the year was $155,500 (excluding the estate purchase of $36,000); shipping costs to acquire the inventory was 3% of the purchase price and 5% of the purchase price is allocated to storage costs.
4. We record depreciation each year on all fixed assets using a system where the depreciation is based on 8% of gross profit recorded for the year. We use this method because it is a uniform approach to recording depreciation. Furniture includes a cleaning machine and other repair equipment, 3 registers, 6 display cabinets, and 3 office (with desks and chairs).

I am sending you this memo because I am wondering if we have accounted for several items correctly. The areas in which I have questions are as follows:

1. During 2022, we acquired some inventory (jewelry) at a private estate auction following the death of the owner. We acquired nine diamond pieces and 21 garnet pieces at a lump-sum price of $36,000 plus an additional $1,800 for sales tax. Our accountant allocated 30% of the $37,800 purchase price to the nine diamond pieces and 70% of the purchase price to the 21 garnet pieces. Three diamonds can probably be sold for $5,500 each and the remaining 6 probably will be sold for $2,750. Eight garnets have a sales value of $750 each and the remaining have a sales value of $325.
2. On December 31, 2022, balance sheet, we reported $280,000 in our Accounts Receivable account and $11,200 in our Allowance for Uncollectible accounts. We use the allowance method of accounting for bad debts and base our bad debts on 4% of gross accounts receivable. On January 7, 2023, our largest customer declared bankruptcy at a time when it owed us $60,000 on account. On December 31, 2022 this customer owed us $50,000. As of that date, the worst-case scenario is that this customer will not be able to pay any of the amounts that it owes, and the best-case estimate is that this customer will be able to pay $.50 on each dollar that is owed. As of today, the best estimate is that this customer will be able to pay $.25 on each dollar that it owes.
3. On August 12, 2022, we sold several pieces of jewelry to a jewelry store that my sister, Jordan Donovan, owns in Grand Rapids, Michigan. These pieces cost our store $115,000 and we sold them to the store in Grand Rapids on account for $200,000, which was $30,000 below the normal retail price of these items. The terms of the sale included 2/30, net 60. My accountant recorded this sale as follows:

Trade Accounts Receivables $200,000

Sales Discounts 30,000

Sales $230,000

Cost of Goods Sold $115,000

Merchandise Inventory $115,000

We have not implemented the new revenue recognition standard since we dont yet

understand how it will impact our business or if it even will. However, after attending a conference last summer, I understand that companies should have some information on sales returns and sales discount amounts with the new standard. Thus, we typically offer discounts when customers pay in less than 20 days of 2%. We estimate that sales returns typically in any given year are 3-5%.

1. On October 1, 2022, we acquired an exclusive patent on how to properly clean precious gems. We acquired this very sophisticated patent by agreeing to make five annual payments of $20,000 each with the first payment being made on October 1, 2022. We recorded this acquisition by debiting the Patent account for $100,000. We allocated the cost of all patents over a 10-year life; therefore, we recorded Depreciation Expense on this patent for 2022 of $2,000 [$20,000/10 years=$2,000]. Because we believe that this patent has so much potential as an investment, we have reported it as a long-term investment on our December 31, 2022 balance sheet. The remaining amount owed on the patent has been included with the accounts payable amount. [If we have not covered this topic, look in your textbook and research the appropriate accounting from the appropriate content in your text.]

If there are any problems in the manner in which we have accounted for any items, please let me know before the audit begins on February 6, 2023. I look forward to hearing from you and seeing what profit we made in the current year.

Hillary, Joan and I have a meeting with Mr. Donavan scheduled for February 1^st. Please examine the memo from Mr. Donovan and determine if you see any problems with the manner in which his company is accounting for any of the items described above.

In addition, do some research on Topic 606, Revenue from contracts with Customers [perform an internet search for this topic and select creditable sources to use.] and provide some guidance related to the standard and determine if any changes should be made to the way the company records revenue transactions. I will need a copy of your memo and any other accompanying support to review two days prior to the meeting.

Requirements:

In groups of two or three:

1. Write a memo to Hillary Duff, one of your audit managers, from you (staff accountant). Your memo should be three to five pages in length, single-spaced. Please leave a line between your paragraphs. In this memo you should provide answers to each question the client has asked.

1. Prepare an income statement, statement of retained earnings and balance sheet in excel (before and after the changes recommended) to illustrate the impact to the statements of the proposed changes. You will need to make sure that the spreadsheet has appropriate headings, flows well, and has links to the recommended changes that you propose. The changes should have specific input areas within the worksheet that will show computations, an appropriate area for input changes and ensure that changes can automatically be updated with different assumption, which will automatically update the changed set of financial statements. Thus, the proposed changes should be able to be manipulated during the meeting with the client to reflect different assumptions the client would like to reflect by changing the inputs in the spreadsheet. (The change statements should be able to automatically be updated to reflect the change in real time for the client).

Notes:

1. Document any assumptions that you make about numbers presented in the statement. Prepare the income statement, statement of retained earnings, and the balance sheet.

1. Needed adjustments may be necessary based in information presented beyond questions 1-4.

1. Your project is due Thursday, November 24^th.

The memo will be worth 85 points and 50 points for the spreadsheet and financial statements. The 85 memo points will be allocated to the quality of the writing and quality of the work (response in addressing the issues). Content will include identifying and addressing appropriate issues and excluding irrelevant points as well as adequately explaining relevant information to the client. Points will also be allocated to the quality of writing which will be graded for organization, grammar, and overall quality (i.e. punctuation, spelling, and clarity). The 50 points allocated to the spreadsheet will include appropriate formulas, presentation of the statements, overall organization of information and accuracy.

Donavan Jewelers
Trial Balance
December 31, 2022
Account Titles		Debit	Credit
Cash					$ 35,800
Accounts Receivable			280,000
Inventory				355,500
Allowance for Doubtful Accounts			11,200
Office Supplies				800
Furniture					275,600
Patent					100,000
Accounts Payable					145,500
Common Stock					200,000
Dividends				1,000
Revenue						783,500
Sales Discounts				30,000
Cost of Goods Sold				193,725
Depreciation Expense		46,782
Rent Expense				55,000
Utilities Expense				15,000
Accumulated Depreciation				92,163
Retained Earnings					156,844
	Totals				$ 1,389,207	$ 1,389,207