look at the instructions. It is a review project in accounting class.

Review Project: Using your Skills from Intermediate I Acct 414 Instructor: Todd Martin INSTRUCTIONS There are two main objectives of financial accounting. The first is to record business transactions. The second is to report the effects of those transactions to our stakeholders. In Intermediate I (Acct 315), we spent a great deal of time working with individual transactions and with reporting information. The purpose of this project is to help you review those basic skills as we get into more advanced transactions in Intermediate II (Acct 414). In addition, this project is intended to give you a feel for the pressures that accountants and other executives are under to manipulate their numbers. As with the ethics case at the beginning of this semester and those you did in Acct 315, my hope for this part of the exercise is to help you find and set your own \"line in the sand\" that you will not cross, no matter what pressures you are facing. Please note that we will have a class discussion about this part of the case after you have turned it in. This case has two parts. The first part (250 points) involves identifying adjustments that need to be made to the financial reporting, making the corrections, and fixing the financial statements. This part of the project (questions 1-7 and all subsections) should be completed with your group. The second part of the case (50 points) involves thinking about the ethics of the scenario. This part of the project (question 8 and all subsections) must be completed individually. The due dates for both parts of the assignment are in the course schedule. Read through the case presented below and answer all of the questions. Your answers should be presented in order and clearly labeled. You may answer more than one part of a question on a page, but each individual topic should be on a separate page. For example, 1a, 1b, 1c, 1d, and 1e can all be on one page, but 2a will need to be on a new page. A template of the financial statements (excluding any formulas) will be available on Blackboard. Your work should all be done on a computer and turned in as one (1) pdf file (for each portion) through Blackboard by 11:00pm on the due date listed in the syllabus. Your work should have a traditional font size, margins, and page layout (i.e. not landscape). The team portion of the project should have a title page that clearly identifies the course, my name, the date, the project title, and the names of all group members. The individual portion of the project should have a similar title page with only your name. Finally, you should take time to edit your writing. Violation of any of these formatting issues will result in a loss of points. As a final note, make sure that your paper is set to standard letter size (8.5\" x 11\"). Papers formatted as legal size CANNOT be printed for the grader and, therefore, WILL NOT be graded! 1 BACKGROUND INFORMATION ClearCrystal Inc. is a growing company that produces crystal service, statues, and other ornaments. The company has focused its effort in the northwest region of the United States, selling it products to tourist shops and high end boutiques throughout the region. The company has been in business for over 100 years, but has remained small due to the wishes of the founder and his children. They believe that keeping the company small will result in providing high quality products and a good working environment for family members and other employees. Last year, however, the last of the founder's children passed away, leaving the business in the hands of three grandchildren. While the founder and his children wished for the company to stay in the family, none of these descendants has been interested in the business. All three already have careers, having used their early experience working in the family business as stepping stones to other business opportunities. Since none of the heirs wished to run the business, and the will prohibited them from selling it off completely, they decided to convert the privately held company into a small publicly traded company. Following the provisions in the will, each maintains a 20% stake in the company, keeping the primary governance within the family, and the rest of the stock was sold on the open market. With the close of the fiscal year fast approaching, the accounting and finance staff are struggling to get the financial statements ready for the company's first audit as a publicly traded company. Since reporting under the SEC's requirements as a publicly-held company are much more stringent than reporting as a privately-held company, the staff has been pushed much harder this year than they have in the past, especially since the founder's grandchildren would like the first 10-k report to reflect positively on the company. INTRODUCTION Dave frowned as he looked over the adjusted trial balance in front of him. Just a few weeks ago he had been happily working at a CPA firm, telling people to fix their books or else. He hadn't realized just how frustrating the job had been for the controllers he had worked with all those years. His new job as controller for ClearCrystal, Inc. includes responsibility for hundreds of reports and forms for internal decision making, preparing the company's budget, overseeing preparation of the tax forms, training for the young (and not so young) accountants on his staff, attending dozens of meetings, and currently creating the financial statements. These are not just any financial statements. They are the very first set of financial statements that would be headed to the SEC. Now that ClearCrystal was a publicly traded company they had to have a much tighter set of financials, and with a sigh he realized that was why he was here. The company hadn't hired 2 him because of his good looks. He had been hired to use his years of public accounting experience to clean up ClearCrystal's books before the auditors showed up. A knock on the door interrupted his thoughts. He looked over his notes one more time. He hoped he was up to the challenge, especially since he would have to delegate most of the work to other members of his staff and hope that he could catch any mistakes in between his other responsibilities. MEETING WITH VICKI \"Good morning,\" Dave said quietly as Vicki, a recent college graduate and the youngest member of Dave's staff, came in. \"I hope you got some rest last night, because I have a lot of fun stuff for you to do today.\" Vicki groaned. \"I hate it when you say that,\" she muttered. \"It never really means fun. It always means more work.\" Dave smiled. \"Well, I think it's fun. I only wish that I had time to do it myself.\" \"Well, don't let me stop you,\" Vicki said quickly. \"If you enjoy it so much...\" Dave couldn't help laughing this time. \"Vicki, if you only knew how much I would prefer to be working on this than the meeting I'll be having with the rest of the team trying to get through this budget project.\" He sighed at the thought of all of the work and long meetings stretching in front of him. \"Yeah, I'd much rather being doing the financial statements. But,\" he paused, \"that's not going to happen. So, instead, I get to pass the fun on to you. Are you up to it?\" Vicki straightened in her chair. \"Of course.\" \"Good! So, here is the adjusted trial balance that I received yesterday morning. It looks pretty good, but there are several pieces missing, transactions that haven't yet been recorded.\" [See Figure 1] \"You can tell there are things missing just be looking over an adjusted trial balance?\" Vicki sounded very impressed. \"No, I'm afraid not. But I can when I go back through the books and don't see certain elements I know should be there. It looks like everything's normal, day to day operations, normal year-end adjustments and the like, were recorded just fine. What are missing are the big things that were done over the course of the year. I assume that's because no one was ever asked to take care of those entries, so they just weren't made. I need you to make them.\" 3 \"I think I can do that.\" \"I hope so, since most of this is stuff you should have studied during your junior year of college. You ready to take some notes?\" Vicki pulled out her tablet and looked up at him expectantly. \"Good. First, no one recorded the creation or the closing of the short-term loan from this past summer. We took out a 4 four month, 6% note in early June for $75,000. Both of those entries will need to be recorded.\" \"Second,\" he paused. \"Are you keeping up?\" \"Yes, sir.\" Vicki said, looking up only briefly from her tablet. \"Excellent. Second, we issued a $750,000 bond on November 30 th to get funds for a couple of investments we wanted to make. The bond is an 8 year, quarterly bond with a 5% stated rate. It was issued at a 4% market rate. No entries have been made for the bond at all.\" \"What about the interest?\" Vicki asked. Dave shook his head. \"We didn't record that either, and don't forget that we use the effective interest method for recording amortization on premiums and discounts.\" \"Third, and last, are the investments that we made with the funds from the bond. We purchased 4,500 shares of Frosty Co. for $20/share and 5,000 shares of JenLou Co. for $15/share. Both of those are for our new expansion fund for the new factory. Almost all of the rest of the proceeds went to purchase 40%, 100,000 shares, of Sampson Mining Co. at $8 per share. They produce most of the gold and silver that we use to accent our crystal.\" \"Wait,\" Vicki said. \"Didn't we buy a controlling interest in the mine?\" Dave nodded. \"We did, but in two pieces. We purchased 100,000 shares for $8 each on January 6 th of last year, the year we are working on for the upcoming audit, and another 50,000 shares for $9 each on January 4th, just a few days ago.\" \"Okay,\" Vicki said. \"Do you know what Sampson reported as income last year?\" \"It was...\" Dave paused as he checked his notes. \"Let's see. Oh, here it is: $92,000. And before you ask, they didn't declare or pay any dividends last year. Any other questions?\" \"I don't think so,\" Vicki said with a frown. \"Oh, yes, do you have the December 31 st stock prices for Frosty and Jenlou?\" \"$18 for Frosty and $17 for Jenlou. I think, though, that we'll report a net expansion fund rather than two separate accounts. It makes the balance sheet a little cleaner.\" \"Okay, I think I've got everything I need. Did you just want the journal entries?\" 4 Dave frowned. \"Of course not. I want the entries, the updated adjusted trial balance, and the financial statements. Here's last year's balance sheet and the information you'll need for the Statement of Cash Flows.\" [See Figures 2 and 3] Stop here and complete requirements 1-3 MEETING WITH THE AUDITOR \"Dave, you look a little tired,\" Marla O'Reily, the lead partner on ClearCrystal's audit, said as she shook his hand. \"Not as easy making the transition from public to private as you had hoped?\" Dave smiled. \"Oh, it's okay. At least I get to stay in the same office for more than a week at a time, and I usually get to go home after only 10 hours a day. That beats my busy season schedule last year by a long shot.\" Marla grimaced. \"You're right there. I'm feeling a little tired myself.\" \"Well, then let's see if we can't get you out of here fast. What's going on?\" \"Oh, not much. But you will need to make a couple of changes. First, we've gone over your pension worksheet and we think that you underestimated your expense a bit. Your estimated return is about 2% too high, and your discount rate is about 3% too low, at least according to our actuaries.\" Dave frowned. \"I guess we can change that, although I'm not sure that I agree that your actuaries are more accurate than mine.\" Marla shrugged. \"We can argue about it if you would like, but I'd prefer not to have to talk about it to your board.\" Dave glanced down at his pension worksheet and sighed. \"Okay. We'll change it. What else?\" [See Figure 4] \"Well, you have a set of inventory that hasn't moved in about 2 years. We think it might be time to write it down or,\" she went on quickly before Dave could say anything, \"at least do a LCM test on it.\" 5 Dave nodded. \"Okay. If it hasn't moved in that long then you are probably right that it needs at least a test. I think,\" he tapped on his tablet for a minute, \"I actually have those numbers right here. Anything else?\" [See Figure 5] \"Just one more. Did you take a good look at your recent lease?\" \"Of course. We capitalized it appropriately.\" Marla shook her head. \"I'm not sure that you did. I mean, I know that the entries look right, but are you sure it was appropriate? Maybe you don't need to capitalize it. If you want to, I won't stop you, but you might want to take another look.\" She handed him a copy of the lease amortization schedule. \"Remember, you don't have a bargain purchase option and you didn't guarantee the residual.\" [See Figure 6] \"Okay, I'll do that. Thanks for providing the option.\" Marla smiled. \"I don't always bring bad news, you know. Unlike some others whose reputation I could mention...\" \"Get outta my office,\" Dave said, waving towards his door. Stop here and complete requirements 4-7 MEETING WITH THE PRESIDENT \"You wanted to see me, Sean?\" Dave asked as he walked into the company president's office. Sean looked up from his computer. \"Ah, Dave. I'm so glad you could stop in for a few minutes.\" He gestured towards a chair. \"Have a seat. I just have one quick thing to talk over with you.\" He held up a copy of the updated financial statements Dave had completed with his team the day before. \"Can you tell me about this lease thing?\" Dave shrugged. \"There's not much to tell. We started a new lease and recorded it appropriately as a capital lease.\" Sean frowned. \"Marla and I had lunch the other day and she suggested that maybe we didn't have to do it that way. It would really help our numbers if we didn't have to record that debt or the extra depreciation.\" 6 \"It might help the numbers, Sean, but I don't think it would be right. I mean, we chose to use a lease because it was a better form of financing, not because we didn't want to buy the asset. We'll own it for essentially all of its useful life, and we'll pay most of its market value. That's a purchase, not rent.\" \"But that's not GAAP, Dave. I really think we should go along with GAAP on this one, especially since this is our first set of financial statements. Let's not rock the boat.\" Dave shifted uncomfortably in his seat. He probably wasn't going to win this fight, but he was going to do his best. \"Maybe, Sean, it is better to have an image right up front that we not only follow GAAP, but we try to show the best information we can to our investors.\" \"Let it go, Dave. Just let it go. You know that I don't like to pull rank on my team, but I will if I have to.\" Complete the final case requirements CASE REQUIRMENTS Many of the entries required below will affect ClearCrystal's taxes. Ignoring the effects of deferred taxes, include a simple adjustment to taxes (adjusting only income tax expense and income tax payable) with each of your entries that would affect ClearCrystal's final net income. You may assume that taxes have already been appropriately recorded for any entry already made. ClearCrystal has a 25% marginal tax rate. Make sure that you incorporate the tax effects when you update the Adjusted Trial Balance and Financial Statements. 1. Make the necessary entries to account for the short-term note, the new bond, and the new investments. Remember that some of these transactions will also require adjusting entries, not just initial entries. 2. Update ClearCrystal's Adjusted Trial Balance to include all of the entries you made in question 1. 3. Create an Income Statement, Balance Sheet, and Statement of Cash Flows for ClearCrystal. Include the prior year in the Balance Sheet for comparison purposes. Keep in mind that a subsequent event (like moving from 40% to 60% of a subsidiary) requires a note to the financial statements telling investors that the values are now different from those reported. 4. Update ClearCrystal's pension worksheet and make the necessary adjusting entry to update the accounts affected by the auditor's adjustments. Do you agree that ClearCrystal needs to make this adjustment? Why or why not? 7 5. Perform a lower of cost of market test on the inventory that Marla questioned and make any necessary adjusting entry using the direct method. Do you agree that ClearCrystal needs to make this adjustment? Why or why not? 6. Reexamine ClearCrystal's capital lease. Can the company reclassify the lease as operating? Why or why not? What entry(ies) would the company need to make to change from a capital lease to an operating lease? Keep in mind that all of the appropriate entries have been made for a capital lease. 7. Assume that the Sean, ClearCrystal's President, has asked to see updated financial information including all three of the changes proposed by the auditor. Update ClearCrystal's adjusted trial balance and financial statements to include your entries from questions 4 through 6. 8. Resolving the conflict between Dave and Sean: Dave (the controller) feels that it would be more accurate to capitalize ClearCrystal's new lease. Sean (the company president) feels that it is more important for a new publicly traded company to follow GAAP to the letter. Using your knowledge of GAAP, ClearCrystal's business goals (that come from the majority stockholders of this closely held corporation), the principles of business ethics, and your answers to questions 1-6, do the following: a. How could Dave convince Sean to agree with his point of view? b. How could Sean convince Dave to agree with his point of view? c. What do you think the final decision will be? Do you agree with that decision? Why or why not? 8 Figure 1: ClearCrystal's Adjusted Trial Balance ClearCrystal Adjusted Trial Balance As of 12/31/Year 1 DR Cash $245,283 A/R $787,500 Allowance for Bad Debts Inventory $1,050,000 Other Current Assets $183,750 Loans to other businesses $350,000 Land $962,500 Building $700,000 Equipment $4,812,500 Leased Assets $355,945 Accumulated Depreciation Accounts Payable Unearned Revenue Current Portion of Loan Payable Pension Obligation Lease Liability Loan Payable Notes Payable Common stock ($2 par, 3,000,000 authorized, 1,800,000 outstanding) Additional Paid-In capital Retained Earnings OCI - Pensions $13,000 Dividends $125,000 Sales Revenue Sales Discounts $87,500 Sales Returns $765,625 Cost of Goods Sold $5,425,000 Advertising Expense $164,063 Bad Debt Expense $21,263 Depreciation Expense $1,267,378 Miscellaneous Selling Expenses $42,656 Pension Expense $9,000 Sales Force Salaries Expense $120,313 Shipping Expense $71,641 Executive Salaries Expense $382,813 Insurance Expense $13,125 Miscellaneous Admin. Expenses $39,320 Rent Expense $31,719 Utilities Expense $65,625 Rent Revenue Loss on Sale of Equipment $50,000 Interest Expense $59,925 Income Tax Expense $40,095 $18,242,539 9 CR $47,250 $1,996,189 $718,153 $218,750 $43,750 $57,000 $276,228 $218,750 $875,000 $3,600,000 $262,500 $1,151,625 $8,750,000 $27,344 $18,242,539 10 Figure 2: ClearCrystal's Year 0 Balance Sheet ClearCrystal Balance Sheet As of 12/31/Year 0 Assets Current Assets Cash A/R Allowance for Bad Debts Inventory Other Current Assets Total Current Assets Long-term Investments Loans to other businesses Total Long-term Investments PPE Land Building Equipment $ 131,250 $ 743,750 $ (44,625) $ 1,225,000 $ 218,750 $2,274,125 $ 350,000 $350,000 $ 612,500 $ 700,000 $ 4,375,000 Accumulated Depreciation $(1,750,000) Total PPE $3,937,500 Total Assets $6,561,625 Liabilities and Stockholders' Equity Current Liabilities Accounts Payable $ 350,000 Unearned Revenue $ 131,250 Current Portion of Loan Payable $ 43,750 Total Current Liabilities $525,000 Long-term Debt Net Pension Obligation $50,000 Loan Payable $ 262,500 Notes Payable $ 700,000 Total Long-term Debt $1,012,500 Total Liabilities $1,537,500 Stockholders' Equity Common stock $ 3,600,000 ($2 par, 3,000,000 authorized, 1,800,000 outstanding) Additional Paid-In capital $ 262,500 Retained Earnings $ 1,151,625 OCI - Pensions $ 10,000 Total Stockholders' Equity $ 5,024,125 Total Liabilities and Stockholder's Equity $6,561,625 11 Figure 3: ClearCrystal's Significant Cash Flows During Year 1 Significant Cash Inflows during Year 1:* Sale of Equipment $250,000 Issuance of Notes Payable $175,000 Significant Cash Outflows during Year 1:* Purchase of Land $350,000 Purchase of Equipment $1,758,689 Repayment of Loans $43,750 Payment of Dividends $125,000 Payment on Capital Leases $79,717 Pension Contribution $25,000 *Note: These cash flows do not include the short-term note or the bond issued by ClearCrystal. Information about those cash flows can be found in the body of the case. 12 Figure 4: ClearCrystal's Original Pension Worksheet (Not Reported) I/S Year 1 Beginning Balances Pension Exp. NA Other Comprehensive Income (OCI) B/S Prior Service Cost Actuaria l Gain/Los s Cash $0 ($10,000 ) NA Memo Amounts Funded Status Projected Benefit Obligatio n (PBO) Plan Assets ($50,000 ) ($750,000 ) $700,000 Adjustment to Prior Service Costs Normal Income Adjustments: Service Cost ( provided by actuary) $20,000 ($20,000) Interest Cost (6% * PBO) $45,000 ($45,000) Expected Returns (8% * Plan ($56,000 $56,000 13 Assets) ) Amortizations Allowed by GAAP: Prior Service Cost Unrecognized Gain/Loss on Accum. OCI Non-Expense Items ($25,00 0) Contributions to the Pension Plan Retirement Benefits Paid Actual Return $25,000 $30,000 ($35,000 ) Actuarial Adjustment to PBO $2,000 14 ($30,000) $35,000 ($2,000) Totals for Journal Entry Ending Balances $9,000 $0 $23,000 $0 $13,000 *List all debits as positive and credits as negative 15 ($25,00 0) ($57,000 ) ($787,000 ) $730,000 Figure 5: ClearCrystal's Inventory Summary Numbers Inventory Summary Item RT-34x Sales Information Units on Hand 1,00 0 Estimated Current Sales Price $50 Typical Markup $25 Cost Information Original Product Cost $60 Estimated Current Product Cost $63 Estimated Disposal Cost $2.6 0 (cleaning and shipping) Figure 6: ClearCrystal's Lease Amortization Schedule LEASEE AMORTIZATION SCHEDULE BPO or Guar. RV $0 PV of RV: 16 $0 Market Value $400,000 INTEREST RATE: $355,945 PAYMENT: $79,717 6.0% TERM in YRS 5 Estimated Economic Life (yrs) 7 Date PV OF MLP: Reduction in Lease Lease Interest Lease Liability Payment Expense Liability BALANCE Oct. 1, Year 1 $355,945 Oct. 1, Year 1 $79,717 $0 $79,717 $276,228 Sept. 30, Year 2 $79,717 $16,574 $63,143 $213,085 Sept. 30, Year 3 $79,717 $12,785 $66,932 $146,153 Sept. 30, Year 4 $79,717 $8,769 $70,948 $75,205 Sept. 30, Year 5 $79,717 $4,512 $75,205 $0 $318,868 $38,128 $280,740 17