On February 20, 20X4 you are well into the field work of the 12/31/20X3 audit and the following issues have arisen during the audit of Beta Computer Equipment Company (BCE.)

1. Service revenue

2. Account receivable from officers

3. Prepaid advertising

4. Alan Almond Company receivable

5. Inventory

6. Bring Your Daughters and Sons to Work Day litigation

Linda Wilson the president of BCE wants you to present your position on each of these issues as she would like your judgment as to good GAAP numbers. But, she has also pointed out that she understands that GAAP often does not provide a precise answer, and in such cases, she would rather error on the side of maintaining income rather than being an overly pessimistic doomsayer. The attitude of Board of Directors members is consistent with that of Linda.

Prepare a memo that summarizes relevant professional standards (standard and paragraph should be cited) related to each of the 6 issues and prepare any proposed journal entries. Discuss information that would be included in any note disclosures related to each of the six items (you need not draft formal note disclosures). Prepare entries for all misstatements you identify, regardless of the amount involved. That is, dont simply say no entry is needed because any amount involved would be immaterial. Assume that the current income is $1,323,839. For purposes of preparing journal entries, you may ignore income tax implications as any changes in taxes will be reflected later in the audit process after any entries have been posted to the working trial balance.

Summarize the income effects (before taxes) of any entries that you propose on a schedule such as the following (make clear over and understatements of income) :

Income Effect

1. Unearned service revenue ____________

2. Account receivable from officers ____________

3. Prepaid advertising ____________

4. Alan Almond Company receivable ____________

5. Inventory ____________

6. Bring your Daughters and Sons to Work Day litigation ____________

Issue 4: Alan Almond Receivable

Alan Almond Company (Alan Almond) owes BCE $82,000 for a computer system installation that was purchased in March of 20X3. Alan Almond has run into financial difficulties due to dramatic decreases in the selling price of almonds during recent years. In August of 20X3 Linda Wilson (BCE president) and Jan Wiggs (BCE controller) established a repayment schedule in which Alan Almond would repay $10,000 per month (plus interest). While the first payment was made in September (bringing the debt down from $92,000 to $82,000), no further payments have been received. (Alan Almond has continued to make small purchases from BCE on a cash basis.)

Your discussion with management indicates that Alan Almond received a going concern modification from its auditors for the year ended 8/30/X3 (the audit report was dated 10/22/X3). The going concern modification arose due to a question concerning whether Alan Almond can obtain new financing when needed, on June 30, 20X4. However, the situation is not entirely bleak for Alan Almonds future as layoffs of 1/3 of the companys employees resulted in a situation in which Alan Almond operated at break even for the year ended 8/30X3. Alan Almond has discussed filing for bankruptcy with bankruptcy legal counsel and at this point believes it is unnecessary. But, if it becomes necessary, counsel suggests that creditors shouldnt expect to receive more than 50 cents on the dollar. Management has suggested to you that 70 cents on the dollar is more likely if bankruptcy ensues. Your analysis at the date of both the Alan Almond audited annual statements (8/30/X3) and the interim statements (11/30/X3) indicates that if bankruptcy is declared, a recovery of 50-60 cents on the dollar (with no amount more probable than another in that range) is likely. Yet, its difficult to know what the situation will be in the future.

The sales agreement for the computer system allows BCE to repossess the equipment at any time prior to bankruptcy. But, because the equipment is used and specific to Alan Almonds applications, management believes that the equipment could be sold for a (net) of between $20,000 and $30,000. Also, management points out that such an action would not be considered positively by either Alan Almond or a number of other companies that BCE is attempting to attract as clients. Accordingly, BCE has resisted this option and does not intend to pursue it at this time.

Your analysis of the interim statements (unaudited) reveals that Alan Almond operated at a slight profit during the first quarter and that almond prices have increased approximately 15 percent. However, experts disagree widely as to future almond prices as there is some concern that a significant increase in almonds from India may enter the US market. Finally, Alan Almonds management, although noncommittal on details, suggests that it believes that it will be able to continue repayments on the debt within the next few months. But your feeling is that it is probable that Alan Almond will be forced to file for bankruptcy.

No allowance for this account is currently included in the allowance for doubtful accounts.

What, if any, loss reserve (and/or note disclosure) should be reflected in the financial statements?