Q U E S T I O N S 1. Review the terms and concepts listed above
Question:
Q U E S T I O N S
1.Review the terms and concepts listed above in Key Terms and Concepts.
2.Reconcile the following two positions:
(1)"Standard-setting bodies need a conceptual framework to guide their selection of alternative accounting principles if the principles are to have a sound foundation and exhibit consistency over time."
(2)"Standard-setting bodies must continually interact with various preparers and users of financial statements to be sure that alternative accounting principles are generally acceptable."
3.A critic of accounting stated: "The financial statements are virtually useless because firms have too much latitude in
selecting from among generally accepted accounting methods." Another critic of accounting reacted: "I agree that the financial statements are useless, but it is because firms have too little latitude in the way they account for certain transac-tions under generally accepted accounting principles." Respond to these statements.
4."The controversy over alternative generally accepted accounting principles disappears if we require all firms to use the same methods of accounting in both their financial statements and their tax return." Respond to this proposal.
5.If net income over sufficiently long time periods equals cash inflows minus cash outflows other than transactions with owners, why not allow the timing of cash flows to dictate the timing of revenue and expense recognition and eliminate alternative GAAP?
6."The total reported net income over sufficiently long time periods is the same regardless of whether a firm follows a conservative strategy or a profit-maximizing strategy in selecting its accounting methods." Explain.
7."The direction of the cumulative effect of two alternative accounting principles on earnings may differ from the direction of the current year's effect." Explain.
8."Alternative accounting principles have less of an effect on the statement of cash flows than on the balance sheet and income statement." Explain.
9.If capital markets react quickly and in an unbiased manner to the release of information, including information contained in the financial statements, what is the benefit of analyzing a set of financial statements?
E X E R C I S E S
10.Identifying generally accepted accounting principles. Indicate the generally accepted accounting principle or method described in each of the following statements. Explain your reasoning.
a.This inventory cost flow assumption results in reporting the largest net income during periods of rising acquisition costs.
b.This method of accounting for uncollectible accounts recognizes the implied income reduction in the period of sale.
c.This method of accounting for long-term investments in the securities of other corporations usually requires an adjustment to net income to calculate cash flow from operations in the statement of cash flows.
d.This method of accounting for long-term leases by the lessee gives rise to a noncurrent liability.
e.This inventory cost flow assumption results in approximately the same balance sheet amount as is produced under the FIFO flow assumption.
f.This method of recognizing interest expense on bonds provides a uniform annual rate of interest expense over the life of the bond.
g.During periods of rising acquisition costs, this inventory valuation basis produces approximately the same results as does the acquisition cost valuation basis.
h.When a firm deems specific customers' accounts uncollectible and writes them off, this method of accounting results in a decrease in the current ratio.
i.This method of depreciation generally provides the largest amounts of depreciation expense during the first several years of an asset's life.
j.This method of accounting for intercorporate investments in securities can result in a decrease in the investor's total shareholders' equity without affecting the Retained Earnings account.
k.This method of recognizing income from long-term contracts generally results in the least amount of fluctuation in earnings over several periods.
l.When a firm identifies specific customers' accounts as uncollectible and writes them off, this method of accounting results in no change in working capital (equals current assets minus current liabilities).
m.When a firm uses this inventory cost flow assumption in calculating taxable income, it generally must use it in calculating net income reported to shareholders.
n.This method of accounting for long-term leases of equipment by the lessor shows on the income statement an amount for depreciation expense.
o.This inventory cost flow assumption results in inventory balance sheet amounts closest to current replacement cost.
p.This method of accounting for long-term investments in securities results in recognizing revenue for dividends received or receivable.
q.This method of depreciation generally results in the largest amounts for depreciable assets on the balance sheet during the first several years of an asset's life.
r.This inventory cost flow assumption results in reporting the smallest net income during periods of falling acquisition costs.
Synthesis: Significance and Implications of Alternative Accounting Principles
2 4
s.The method of accounting for long-term leases of equipment by the lessee results in showing an amount for rent expense on the income statement.
t.This inventory cost flow assumption results in inventory balance sheet amounts that may differ significantly from current replacement cost.
u.This method of accounting for long-term leases of equipment by the lessor results in showing revenue at the time of signing a lease.
v.This inventory cost flow assumption can result in substantial changes in the relation between cost of goods sold and sales if inventory quantities decrease during a period.
11.Identifying generally accepted accounting principles. Indicate the accounting principle or procedure apparently being used to record each of the following independent transactions. Also describe the transaction or event being recorded.
a.Retained Earnings (Bad Debt Expense) (Shareholders' Equity Decrease) . . . . . . . . . . . . .
X
Accounts Receivable (Asset Decrease). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
X
b.Cash (Asset Increase) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
X
Retained Earnings (Dividend Revenue) (Shareholders' Equity Increase) . . . . . . . . . .
X
c.Accumulated Other Comprehensive Income (Unrealized Holding Loss on
Marketable Securities Available for Sale) (Shareholders' Equity Decrease) . . . . . . . . . .
X
Marketable Securities (Asset Decrease) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
X
d. Cash (Asset Increase) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
X
Investment in Affiliated Company (Asset Decrease) . . . . . . . . . . . . . . . . . . . . . . .
X
Dividend declared and received from affiliated company.
e.Retained Earnings (Bad Debt Expense) (Shareholders' Equity Decrease) . . . . . . . . . . . . .
X
Allowance for Uncollectible Accounts (Asset Decrease) . . . . . . . . . . . . . . . . . . . . .
X
f.Retained Earnings (Rent Expense for Lease) (Shareholders' Equity Decrease). . . . . . . . .
X
Cash (Asset Decrease). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
X
g.Investment in Affiliated Company (Asset Increase). . . . . . . . . . . . . . . . . . . . . . . . . .
X
Retained Earnings (Equity in Earnings of Affiliated Company)
(Shareholders' Equity Increase). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
X
h. Allowance for Uncollectible Accounts (Asset Increase). . . . . . . . . . . . . . . . . . . . . . . .
X
Accounts Receivable (Asset Decrease). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
X
i.Retained Earnings (Loss from Price Decline of Inventories)
(Shareholders' Equity Decrease). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
X
Merchandise Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
X
j.Liability under Long-term Lease (Liability Decrease) . . . . . . . . . . . . . . . . . . . . . . . . . .
X
Retained Earnings (Interest Expense) (Shareholders' Equity Decrease) . . . . . . . . . . . . . .
X
Cash (Asset Decrease). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
X
12.Identifying effects of generally accepted accounting principles on reported income. Indicate the accounting princi-ple that provides the smallest amount of cumulative earnings in each of the following cases:
a.The valuation of inventories at acquisition cost or lower of cost or market
b.FIFO, LIFO, or weighted-average cost flow assumption for inventories during periods of rising acquisition costs
c.FIFO, LIFO, or weighted-average cost flow assumption for inventories during periods of declining acquisition costs
d.Market value method or equity method of accounting for long-term investments in securities when the investee declares dividends less than its earnings
e.Market value method or equity method of accounting for long-term investments in the securities of unconsolidated subsidiaries when the investee realizes net losses and does not pay dividends
f.Sum-of-the-years'-digits or straight-line depreciation method during the first one-third of an asset's life
g.Sum-of-the-years'-digits or straight-line depreciation method during the last one-third of an asset's life
h.The operating lease method or the capital lease method for the lessee during the first several years of the life of a lease
i.The operating lease method or the capital lease method for the lessor during the last several years of the life of a lease
Synthesis: Significance and Implications of Alternative Accounting Principles
2 5
PROBLEMS AND CASES
13.Impact of capitalizing and amortizing versus expensing when incurred. West Company, a U.S. company, and East Company, a Japanese company, incur $100 million of research and development (R&D) costs each year. West Company must expense these costs immediately, whereas East Company capitalizes the costs and amortizes them over five years.
a.For each of the first six years, compute the amount of R&D expense that each firm would report on the income statement and the amount of deferred R&D costs that each firm would report on the balance sheet.
b.For this part, assume that the amount of R&D costs incurred by each firm increases by $20,000 million each year. Repeat part a.
c.Comment on the differences noted in parts a and b.
14.Impact of alternative accounting principles on two firms. On January 1, Year 1, two corporations establish merchan-dising businesses. The firms are alike in all respects except for their methods of accounting. Humble Company chooses the accounting principles that minimize its reported net income. Huff Company chooses the accounting principles that maximize its reported net income but, where permitted, uses accounting methods that minimize its taxable income. The following events occur during Year 1.
(1)Both firms issue 500,000 shares of $1-par value common shares for $8 per share on January 1, Year 1.
(2)Both firms acquire equipment on January 2, Year 1, for $2,750,000 cash. The firms estimate the equipment to have a 10-year life and zero salvage value.
(3)Both firms engage in extensive sales promotion activities during Year 1, incurring costs of $375,000.
(4)The two firms make the following purchases of merchandise inventory, on account.
Date
Units Purchased
Unit Price
Cost of Purchase
January 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
30,000
$8.00
$
240,000
April 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
80,000
8.10
648,000
August 15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20,000
8.25
165,000
November 30 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
70,000
8.40
588,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
200,000
$1,641,000
On December 31, Year 1, purchases of inventory on account totaling $310,000 remain unpaid.
(5)During the year, both firms sell 150,000 units at an average price of $18 each.
(6)Selling, general, and administrative expenses, other than advertising, total $150,000 during the year.
Humble Company uses the following accounting methods (for both book and tax purposes): LIFO inventory cost flow assumption, accelerated depreciation, and immediate expensing of the costs of sales promotion. It uses the sum-of-the-years'-digits depreciation method for financial reporting and the allowable accelerated depreciation method for tax purposes. For tax purposes, depreciation on this equipment is $293,700 for Year 1.
Huff Company uses the following accounting methods: FIFO inventory cost flow assumption for both book and tax purposes, the straight-line depreciation method for book and the allowable accelerated depreciation method for tax purposes, and capitalization and amortization of the costs of the sales promotion campaign over four years for book and immediate expensing for tax purposes.
a. Prepare comparative income statements for the two firms for Year 1. Include separate computations of income tax expense. The income tax rate is 30 percent.
b.Prepare comparative balance sheets for the two firms as of December 31, Year 1. Both firms have $1,300,000 of out-standing accounts receivable on this date. Each firm has a current liability for unpaid income taxes equal to one-fifth of the taxes payable on the current year's taxable income.
c.Prepare comparative statements of cash flows for the two firms for Year 1, defining funds as cash.
d. analysis that explains the difference in the cash of Humble Company and that of Huff Company on December 31, Year 1.
15.Impact of two sets of alternative accounting principles on net income and cash flows. Brown Corporation com-mences operations on January 2, Year 1, with the issuance at par of 100,000 shares of $10-par value common stock for cash. During Year 1, the following transactions occur.
(1)Brown Corporation acquires the assets of Joan's Department Store on January 2, Year 1, for $600,000 cash. The market values of Joan's identifiable assets are as follows: accounts receivable, $150,000; merchandise inventory, $300,000 (150,000 units); store equipment, $112,500; and goodwill, $37,500.
(2)During the year, the firm sells 157,500 units at an average price of $3.20.
(3)The firm offers extensive training programs during the year to acquaint previous employees of Joan's Department Store with the merchandising policies and procedures of Brown Corporation. The costs incurred in the training programs total $37,500.
(4)Selling, general, and administrative costs incurred and recognized as an expense during Year 1 are $60,000.
Synthesis: Significance and Implications of Alternative Accounting Principles
2 6
(5)Brown Corporation purchases, on account, merchandise inventory during Year 1 as follows:
Date
Units Purchased
Unit Price
Cost of Purchase
April 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
22,500
$2.10
$
47,250
August 1. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15,000
2.20
33,000
October 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
37,500
2.40
90,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
75,000
$170,250
On December 31, Year 1, Brown Corporation owes $30,200 for purchases on account.
(6)Brown Corporation estimates the store equipment to have a 10-year useful life and zero salvage value.
(7)The income tax rate is 30 percent.
The management of Brown Corporation is uncertain about the accounting methods that it should use in prepar-ing its financial statements. It narrows the choice to two sets of accounting methods and asks you to calculate net income for Year 1 using each set.
Set A consists of the following accounting methods (for book and tax purposes): LIFO inventory cost flow assumption, accelerated depreciation, and immediate expensing of the costs of the training program. Set A com-putes depreciation using the double declining-balance method for book purposes (10-year useful life and zero estimated salvage value). Accelerated depreciation for tax purposes is $16,073.
Set B consists of the following accounting methods: FIFO inventory cost flow assumption, straight-line depre-ciation for book purposes (10-year life and zero estimated salvage value), and capitalization and amortization of the costs of the training program over five years for book and immediate expensing for tax purposes. Accelerated depreciation for tax purposes is $16,073.
a. Calculate the net income for Year 1 under each set of accounting methods.
b.Calculate cash flow from operations under each set of accounting methods. Assume that accounts receivable total $120,000 and accounts payable total $30,200 at year-end. Also assume that one-fourth of the income taxes payable on the current year's taxable income remains unpaid at year-end.
c.Prepare an analysis that explains the difference in cash flow from operations under Set A and Set B.
16.Comprehensive review problem. Exhibits 7 and 8 present a partial set of financial statements of Chicago Corporation for Year 2, including a consolidated statement of income and retained earnings for Year 2 and consolidated comparative balance sheets at December 31, Year 1 and Year 2. A series of questions relating to the financial statements of Chicago Corporation follows these financial statements. You should study the financial statements before responding to these ques-tions and problems. Additional information is as follows:
EXHIBIT 7CHICAGO CORPORATION
Consolidated Statement of Income and Retained Earnings for Year 2 (Problem 16)
Revenues
Sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$13,920,000
Gain on Sale of Machinery and Equipment . . . . . . . . . . . . . . . . .
200,000
Equity in Earnings of Affiliates:
Chicago Finance Corporation . . . . . . . . . . . . . . . . . . . . . . . . .
$1,800,000
Rosenwald Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
125,000
Hutchinson Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
75,000
2,000,000
Total Revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$16,120,000
Expenses
Cost of Goods Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
5,000,000
Employee Payroll . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3,000,000
Depreciation of Plant and Equipment and Amortization
of Leased Property Rights. . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,000,000
Amortization of Patent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
125,000
Bad Debt Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
120,000
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
455,000
General Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
420,000
Income TaxesCurrent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,430,000
Income TaxesDeferred. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
170,000
Total Expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$11,720,000
Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
4,400,000
Less: Dividends on Preferred Shares. . . . . . . . . . . . . . . . . . . . .
(120,000)
Dividends on Common Shares . . . . . . . . . . . . . . . . . . . . . .
(2,080,000)
(continued on next page)
Synthesis: Significance and Implications of Alternative Accounting Principles
2 7
(continued from previous page)
Increase in Retained Earnings. . . . . . . . . . . . . . . . . . . . . . . . .
$
2,200,000
Retained Earnings, January 1, Year 2. . . . . . . . . . . . . . . . . . . .
2,800,000
Retained Earnings, December 31, Year 2. . . . . . . . . . . . . . . . . .
$
5,000,000
Basic Earnings per Common Share (based on
1,600,000 average shares outstanding). . . . . . . . . . . . . . . . .
$2.675
Fully Diluted Earnings per Share (assuming conversion
of preferred stock). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2.20
(1)During Year 2, Chicago Corporation sold, for cash, machinery and equipment costing $1,000,000 and with a book value of $200,000.
(2)The only transaction affecting common or preferred stocks during Year 2 was the sale of treasury stock.
(3)The bonds payable have a maturity value of $4 million.
a.Compute the amount of specific customers' accounts that Chicago Corporation wrote off as uncollectible during Year 2, assuming that it made no recoveries during Year 2 on accounts written off in years prior to Year 2.
b.Chicago Corporation uses the LIFO cost flow assumption in computing its cost of goods sold and its beginning and ending merchandise inventory amounts. If it had used a FIFO cost flow assumption, the beginning inventory would have been $1,800,000 and the ending inventory would have been $1,700,000. Compute the actual gross profit (net sales less cost of goods sold) of Chicago Corporation for Year 2 under LIFO and the corresponding amount of gross profit if FIFO had been used (ignore income tax effects).
c.Refer to part b. Did the quantity and acquisition costs of merchandise inventory increase or decrease between the beginning and the end of Year 2? Explain.
d.Chicago Corporation accounts for its three intercorporate investments in unconsolidated affiliates using the equity method. It acquired the shares in each of these companies at book value at the time of acquisition. How much did each of these three companies declare in dividends during Year 2? How can you tell?
e.Chicago Corporation accounts for its three intercorporate investments in unconsolidated affiliates using the equity method. It acquired the shares in each of these companies at book value at the time of acquisition. Give the journal entry (entries) made during Year 2 to apply the equity method.
f.Chicago Corporation acquired its only building on January 1, Year 1. It estimated the building to have a 40-year use-ful life and zero salvage value at that time. Calculate the amount of depreciation expense on this building for Year 2, assuming that the firm uses the double declining-balance method.
g.Chicago Corporation sold machinery and equipment costing $1,000,000, with a book value of $200,000, for cash during Year 2. Give the journal entry to record the disposition.
h.The bonds payable carry 6 percent annual coupons and require the payment of interest on December 31 of each year. Give the journal entry made on December 31, Year 2, to recognize interest expense for Year 2, assuming that Chicago Corporation uses the effective interest method.
i.Refer to part h. What was the effective or market interest rate on these bonds on the date they were issued? Explain.
j.The $170,000 deferred portion of income tax expense for Year 2 includes $150,000 relating to the use of different depreciation methods for financial and tax reporting. If the income tax rate was 30 percent, calculate the difference between the depreciation deduction reported on the tax return and the depreciation expense reported on the income statement.
k.Give the journal entry that explains the change in the treasury shares account assuming that no other transactions affected the common or preferred shares during Year 2.
l.If the original acquisition cost of the patent is $1,250,000, and the firm amortizes the patent on a straight-line basis, how long before December 31, Year 2, did the firm acquire the patent?
m.Chicago Corporation acquired the stock of Hutchinson Company on December 31, Year 1. If it held the same amount of stock during the year, but the amount represented only a 15 percent ownership of the Hutchinson Company, how would the financial statements have differed? Disregard income tax effects, and assume the market price of the shares exceeds their acquisition cost of $100,000 by $25,000 on December 31, Year 2.
n.During Year 2, Chicago Corporation paid $170,000 to the lessor of property represented on the balance sheet by "Property Rights Acquired under Lease." Property rights acquired under lease have a 10-year life, and Chicago Corporation amortizes them on a straight-line basis. What was the total expense reported by Chicago Corporation during Year 2 from using the leased property?
o.How would the financial statements differ if Chicago Corporation accounted for inventories on the lower-of-cost-or-market basis and if the market value of these inventories had been $1,600,000 at the end of Year 2? Disregard income tax effects.
p.Refer to the earnings-per-share amounts in the income statement of Chicago Corporation. How many shares of common stock would the firm issue if holders of the outstanding shares of preferred stock converted them into common stock?
q.The treasurer of Chicago Corporation recently remarked, "The value or worth of our company on December 31, Year 2, is $11,000,000, as measured by total shareholders' equity." Describe briefly at least three reasons why the difference between recorded total assets and recorded total liabilities on the balance sheet does not represent the firm's value or worth.
Synthesis: Significance and Implications of Alternative Accounting Principles
2 8
r.Some financial statement users criticize the accounting profession for permitting several GAAP for the same or sim-ilar transactions. What are the major arguments for (1) narrowing the range of acceptable methods or (2) continu-ing the present system of permitting business firms some degree of flexibility in selecting their accounting methods?
EXHIBIT 8
CHICAGO CORPORATION
Consolidated Balance Sheets, December 31 (Problem 16)
Year 1
Year 2
ASSETS
Current Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
200,000
$
100,000
Certificate of Deposit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
225,000
Accounts Receivable (net of estimated uncollectibles of $100,000
in Year 1 and $160,000 in Year 2) . . . . . . . . . . . . . . . . . . . . .
500,000
600,000
Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,500,000
1,800,000
Prepayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
200,000
200,000
Total Current Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 2,400,000
$
2,925,000
Investments (at equity)
Chicago Finance Corporation (40 percent owned). . . . . . . . . . . . .
$ 2,200,000
$
4,000,000
Rosenwald Company (50 percent owned) . . . . . . . . . . . . . . . . . .
900,000
1,025,000
Hutchinson Company (25 percent owned) . . . . . . . . . . . . . . . . . .
100,000
175,000
Total Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 3,200,000
$
5,200,000
Property, Plant, and Equipment
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
400,000
$
500,000
Building. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4,000,000
4,000,000
Machinery and Equipment. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7,300,000
8,000,000
Property Rights Acquired under Lease. . . . . . . . . . . . . . . . . . . .
1,500,000
1,500,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$13,200,000
$14,000,000
Less Accumulated Depreciation and Amortization. . . . . . . . . . . . .
(3,800,000)
(4,000,000)
Total Property, Plant, and Equipment . . . . . . . . . . . . . . . . . . .
$ 9,400,000
$10,000,000
Intangibles (at net book value)
Patent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
875,000
$
750,000
Goodwill. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,125,000
1,125,000
Total Intangibles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 2,000,000
$
1,875,000
Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$17,000,000
$20,000,000
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
400,000
$
550,000
Advances from Customers. . . . . . . . . . . . . . . . . . . . . . . . . . . .
660,000
640,000
Salaries Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
240,000
300,000
Income Taxes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
300,000
430,000
Rent Received in Advance . . . . . . . . . . . . . . . . . . . . . . . . . . . .
50,000
Other Current Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
200,000
460,000
Total Current Liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 1,800,000
$
2,430,000
Long-term Debt
Bonds Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
3,600,000
$
3,648,000
Equipment Mortgage Indebtedness. . . . . . . . . . . . . . . . . . . . . .
1,300,000
332,000
Capitalized Lease Obligation . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,100,000
1,020,000
Total Long-term Debt. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
6,000,000
$
5,000,000
Deferred Tax Liability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 1,400,000
$
1,570,000
Shareholders' Equity
Convertible Preferred Stock. . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 2,000,000
$
2,000,000
Common Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,000,000
2,000,000
Additional Paid-in Capital. . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,400,000
3,000,000
Retained Earnings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,800,000
5,000,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 9,200,000
$12,000,000
Less Cost of Treasury Shares . . . . . . . . . . . . . . . . . . . . . . . . . . .
(1,400,000)
(1,000,000)
Total Shareholders' Equity . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 7,800,000
$11,000,000
Total Liabilities and Shareholders' Equity. . . . . . . . . . . . . . . .
$17,000,000
$20,000,000
Synthesis: Significance and Implications of Alternative Accounting Principles
2 9
17.Comprehensive review problem. Exhibit 9 presents a consolidated statement of income and retained earnings for Year 22, and Exhibit 10 presents a consolidated balance sheet for Tuck Corporation as of December 31, Year 21 and Year 22. A statement of accounting policies and a set of notes to the financial statements appear below. After studying these finan-cial statements and notes, respond to each of the following questions and calculation requirements.
a.Prepare an analysis that explains the change in the Marketable Equity Securities account during Year 22.
b.Calculate the proceeds from sales of marketable equity securities classified as current assets during Year 22.
c.Calculate the amount of the estimated uncollectible accounts provision made during Year 22.
d.Calculate the amount of cost of goods sold assuming Tuck Corporation used a FIFO cost flow assumption.
e.Give the journal entry(s) to account for the change in the Investment in Thayer Corporation account during Year 22.
f.Calculate the amount of income or loss from the Investment in Thayer Corporation during Year 22.
g.Give the journal entry(s) to account for the change in the Investment in Davis Corporation account during Year 22.
h.Refer to Note 5. Give the journal entry to record the sale of equipment during Year 22.
i.Refer to Note 9. Demonstrate that the $106,036 is the correct amount of the leasehold asset at the beginning of the lease term.
j.Calculate the amount of cash received during Year 22 for rental fees.
k.Calculate the actual cost of goods and services required to service customers' warranties during Year 22.
l.Refer to Note 7. Calculate the amount of interest expense on the $1 million, 6 percent bonds for Year 22.
m.Give the journal entry(s) for the change in the Mortgage Payable accounts during Year 22. Be sure to consider the current portion.
n.Verify that the book value of the combined current and noncurrent portions of the Capitalized Lease Obligation on December 31, Year 21, should be $62,064.
o.Prepare an analysis that explains the change in the book value of the combined current and noncurrent portions of the Capitalized Lease Obligation during Year 22.
p.Give the journal entry to record income tax expense for Year 22.
q.Compute the amount of cash payments for income taxes during Year 22.
r.The income tax rate is 30 percent. Assume that during Year 22, Tuck Corporation recognized $12,000 of deferred tax expense related to differences in depreciation methods. Calculate the difference between the amount of depre-ciation recognized for financial reporting purposes and the amount recognized for tax purposes.
s.Give the journal entry made on July 1, Year 22, upon conversion of the preferred stock.
t.Give the journal entry(s) to account for the change in the Treasury Stock account during Year 22.
EXHIBIT 9
TUCK CORPORATION
Consolidated Statement of Income and Retained Earnings for Year 22 (Problem 17)
Revenues and Gains
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$4,000,000
Gain on Sale of Equipment. . . . . . . . . . . . . . . . . . . . . . . . . . .
3,000
Rental Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
240,000
Dividend Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8,000
Equity in Earnings of Unconsolidated Affiliates . . . . . . . . . . . . . .
102,000
Total Revenues and Gains . . . . . . . . . . . . . . . . . . . . . . . . . . .
$4,353,000
Expenses, Losses, and Deductions
Cost of Goods Sold (including depreciation and amortization) . . . .
$2,580,000
Selling and Administration Expenses (including depreciation
and amortization) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,102,205
Warranty Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
46,800
Interest Expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
165,995
Loss on Sale of Marketable Equity Securities. . . . . . . . . . . . . . .
8,000
Income Tax Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
150,000
. . . .TotalExpenses,Losses,andDeductions.............
4,053,000
Consolidated Net Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
300,000
Less Dividends Declared . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(119,500)
Increase in Retained Earnings for Year 22. . . . . . . . . . . . . . . . .
$
180,500
Retained Earnings, December 31, Year 21 . . . . . . . . . . . . . . . . . .
277,000
Retained Earnings, December 31, Year 22 . . . . . . . . . . . . . . . . . .
$
457,500
Synthesis: Significance and Implications of Alternative Accounting Principles
3 0
TUCK CORPORATION
EXHIBIT 10
Consolidated Comparative Balance Sheet (Problem 17)
December 31,
December 31,
Year 21
Year 22
ASSETS
Current Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
240,000
$
278,000
Marketable Securities (Note 1)
. . . . . . . . . . . . . . . . . . . . . . . . .
125,000
141,000
Accounts ReceivableNet (Note 2). . . . . . . . . . . . . . . . . . . . .
1,431,200
1,509,600
Inventories (Note 3). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,257,261
1,525,315
Prepayments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
28,000
32,000
Total Current Assets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$3,081,461
$3,485,915
Investments (Note 4)
Investment in Thayer Corporation (15 percent owned). . . . . . . .
$
92,000
$
87,000
Investment in Hitchcock Corporation (30 percent owned). . . . . .
120,000
135,000
Investment in Davis Corporation (40 percent owned). . . . . . . . .
215,000
298,000
Total Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
427,000
$
520,000
Property, Plant, and Equipment (Note 5)
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
82,000
$
82,000
Building. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
843,000
843,000
Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
497,818
1,848,418
Leasehold. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
106,036
106,036
Total Plant Assets at Cost.
. . . . . . . . . . . . . . . . . . . . . . . . .
$1,528,854
$2,879,454
Less Accumulated Depreciation and Amortization. . . . . . . . . . . .
(383,854)
(420,854)
Total Plant AssetsNet . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,145,000
$2,458,600
Intangibles
GoodwillNet. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
36,000
$
36,000
Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$4,689,461
$6,500,515
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Note Payable (Note 6). . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
100,000
$
200,000
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
666,100
723,700
Rental Fees Received in Advance. . . . . . . . . . . . . . . . . . . . . . .
46,000
58,000
Estimated Warranty Liability.
. . . . . . . . . . . . . . . . . . . . . . . . .
75,200
78,600
Interest Payable on Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,500
2,000
Dividends Payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
25,000
30,000
Income Taxes PayableCurrent
. . . . . . . . . . . . . . . . . . . . . . . . .
140,000
160,000
Mortgage PayableCurrent Portion . . . . . . . . . . . . . . . . . . . . . .
37,383
37,383
Capitalized Lease ObligationCurrent Portion. . . . . . . . . . . . . .
10,000
10,000
Total Current Liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,101,183
$1,299,683
Noncurrent Liabilities
Bonds Payable (Note 7). . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$1,104,650
$1,931,143
Mortgage Payable (Note 8). . . . . . . . . . . . . . . . . . . . . . . . . . .
262,564
243,560
Capitalized Lease Obligation (Note 9) . . . . . . . . . . . . . . . . . . . .
52,064
46,229
Deferred Tax Liability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
130,000
145,000
Total Noncurrent Liabilities
. . . . . . . . . . . . . . . . . . . . . . . . .
$1,549,278
$2,365,932
Total Liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,650,461
$3,665,615
Shareholders' Equity
Convertible Preferred Stock, $100 par Value (Note 10) . . . . . . . . .
$
700,000
$
200,000
Common Stock, $10 par Value (Note 11) . . . . . . . . . . . . . . . . . .
1,000,000
1,650,000
Additional Paid-in CapitalCommon . . . . . . . . . . . . . . . . . . . . .
130,000
583,600
Accumulated Other Comprehensive Income:
Unrealized Holding Loss on Marketable Securities. . . . . . . . . .
(25,000)
(21,000)
Unrealized Holding Loss on Investments in Securities. . . . . . .
(16,000)
(21,000)
Retained Earnings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
277,000
457,500
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$2,066,000
$2,849,100
Less Cost of Treasury Stock (Note 12) . . . . . . . . . . . . . . . . . . . .
(27,000)
(14,200)
Total Shareholders' Equity.
. . . . . . . . . . . . . . . . . . . . . . . . .
$2,039,000
$2,834,900
Total Liabilities and Shareholders' Equity. . . . . . . . . . . . . . . .
$4,689,461
$6,500,515
Synthesis: Significance and Implications of Alternative Accounting Principles
3 1
STATEMENT OF ACCOUNTING POLICIES
Basis of consolidation. Tuck Corporation consolidates its financial statements with those of Harvard Corporation, a 100-percent-owned subsidiary acquired on January 2, Year 20.
Marketable equity securities. The firm reports marketable securities at market value.
Accounts receivable. The firm accounts for customers' uncollectible accounts using the allowance method.
Inventories. Tuck Corporation uses a last-in, first-out (LIFO) cost flow assumption for inventories.
Investments. The firm accounts for investments of less than 20 percent of the outstanding common stock of other companies using the market value method. It accounts for investments of 20 to 50 percent of the outstanding com-mon stock of affiliates using the equity method.
Building, equipment, and leaseholds. Tuck Corporation calculates depreciation for financial reporting purposes using the straight-line method and for income tax reporting using MACRS depreciation.
Goodwill. The firm does not amortize goodwill in accordance with FASB Statement of Financial Accounting Standards No. 142.
Interest expense on long-term debt. The firm measures interest expense on long-term debt using the effective interest method.
Deferred income taxes. Tuck Corporation provides deferred income taxes for temporary differences between book and taxable income.
NOTES TO THE FINANCIAL STATEMENTS
Note 1: The balance sheet presents marketable equity securities at market value, which is less than acquisition cost by $25,000 on December 31, Year 21, and $21,000 on December 31, Year 22. Tuck Corporation sold marketable equity secu-rities costing $35,000 during Year 22. It received no dividends from marketable equity securities during Year 22.
Note 2: The balance sheet presents accounts receivable net of an allowance for uncollectible accounts of $128,800 on December 31, Year 21, and $210,400 on December 31, Year 22. Tuck Corporation wrote off a total of $63,000 of accounts receivable as uncollectible during Year 22.
Note 3: The valuation of inventories on a FIFO basis exceeded the amounts on a LIFO basis by $430,000 on Decem-ber 31, Year 21, and by $410,000 on December 31, Year 22.
Note 4: Davis Corporation reported net income for Year 22 of $217,500 and declared and paid dividends totaling $60,000
Expert Answer:
