Rico Corp. manufactures exercise equipment for commercial health clubs and home gyms. The company was started 15 years ago, and, after initial start-up difficulties, now has an established reputation as an industry leader in high-quality and versatile exercise equipment.  

The company is owned by a group of investors who hope to either take the company public in the next five years or be an acquisition target of a larger public company. Accordingly, management is interested in steady growth in accounting income. Lending arrangements require audited financial statements. It is now the end of the 20X4 fiscal year, and several issues have yet to be resolved.  

You, Denise LaTour, are a professional accountant with a role in the VP Finance office of Rico. You have been asked to prepare a report for the audit committee on these issues. Inventory has always been valued using first-in, first-out cost flow assumption. It has been suggested that the company switch to average cost, in order to be comparable to industry norms.  

The cost of inventory would be 10% lower under average cost than under FIFO at the end of 20X4. It is not clear that the average cost of prior inventory balances could be ascertained. With respect to accounts receivable, the company has always established an allowance for doubtful accounts, based on an assessment of aged accounts receivable. However, estimates of bad debts have not been accurate in the past.  

Accordingly, it has been suggested that the company switch to a direct write-off approach, where accounts would be written off only after collection initiatives were exhausted. Prior balances could be recreated, and the reliability of the bad debt expense would increase. Rico's term financing with its bank involved an up-front fee.  

This was paid to the bank when the loan was initially negotiated, three years ago. The amount was expensed at that time. Now it has been suggested that the up-front fee should have been deferred as an asset, and expensed over the life of the loan on a straight-line basis. Prior balances could be re-created.

 

Instructions 

Please prepare case report outlining all accounting/financial reporting issues.