See attachment. Audit Question. Pretending you are on an audit team.

***Pretend you are on an audit team in order to complete Parts 1 and 2*** Part 1: You are reviewing the property, plant, and equipment working papers of Free Manufacturing, a company that produces parachutes. The lead schedule, prepared by the client for you, is Appendix A (last page). The beginning balance numbers agree to prior year work papers. Ending balance numbers agree to the trial balance. When looking into the additions and retirements, you noted the following items. After each finding, determine if an adjusting entry is required. Free Manufacturing prepares their financial statements in accordance with US GAAP. Indicate your proposed AJE or indicate no AJE after each finding. (Use a different font or color) 1. Land. The addition represents the purchase of land adjacent to company's existing plant and is financed as follows: Free Manufacturing exchanged 2000 shares of Common Stock and assumed liabilities on accrued county taxes at settlement date and unpaid sewer installation assessment for the land. On June 17, the date on which the buyer and seller discussed the transaction, shares of Free Manufacturing stock were selling for $77.50. On June 30, the settlement date (day of the sale), Free Manufacturing was selling for $70.00 per share. The journal entry for the purchases was recorded as: Land 166,000 Common Stock PIC in excess of Par Accrued Taxes Payable Accrued sewer assessment Payable 20,000 135,000 4,600 6,400 2. Land Improvements. This account was increased by three journal entries (each recorded with a debit to land improvements and a credit to cash) during the year. Each of these improvements relates to the new land which was purchased above. Sidewalk to building $2,500 Repaving of road to building 3,500 Chain link fence 4,000 3. Building. An independent contractor constructed the building; the contract price was for $475,000. Free Manufacturing borrowed funds to pay the independent contractor and incurred interest of $20,000 on the bank loan during the construction period. The interest of $20,000 was capitalized as part of the building and the interest subsequent to construction but prior to year end of $15,000 was expensed. 4. Equipment: The change in the equipment was an updating to equipment. An old machine with a net book value and a fair value of $19,400 and an original cost of $60,000 was traded for a new piece equipment with a value of $110,000. Free Manufacturing also kicked in $90,600 of cash. The following entry was recorded. Gain on Exchange Equipment Equipment Cash 40,600 $110,000 60,000 90,600 5. Depreciation Provision. Free Manufacturing uses software to calculate depreciation to the exact day. Determine the reasonableness of depreciation expense by preparing a calculation of the deprecation provisions and comparing to the client's recorded amounts. For this calculation, assume that acquisitions, on average, occur at midyear. If the provision does not appear reasonable, discuss any concerns that you have. Use the following table for your calculation. Acct. Rate 152-3 5% 154-5 3% 156-7 10% Depr. On Beginning Balance Add: Depr. on Additions Less: Depr. on Retirements Estimated Depreciation Book Depreciation Difference Totals Part 2: During the audit, your audit team noted the below changes in certain financial statement ratios or amounts from the prior year's ratios or amounts. For each noted change, discuss with your team what might have caused this change and then choose one, two or three explanations (as indicated) by checking the appropriate boxes in the table. Each explanation may be used once, more than once, or not at all. Noted Changes: 1. Noncurrent debt increased from the prior year, but interest expense increased by an amount that was proportionately greater than the increase in noncurrent debt. (Choose one explanation). 2. Accounts receivable turnover increased substantially form the prior year. (Choose three explanations). 3. The allowance for doubtful accounts increased from the prior year, but, as a percentage of accounts receivable, it decreased from the prior year. (Choose three explanations). 4. Operating income increased from the prior year, although the entity was less profitable than in the prior year. (Choose two explanations). 5. The gross margin percentage was unchanged from the prior year, although gross margin increased from the prior year. (Choose one explanation). 6. Inventory turnover increased substantially from the prior year. (Choose three explanations). 2 3 4 5 6 Explanation The effective income tax rate increased, as compared with the prior year. The effective income tax rate decreased, as compared with the prior year. Items shipped on consignment during the last month of the year were recorded as sales. Sales increased by the same percentage as cost of goods sold, as compared with the prior year. The same percentage of sales occurred during the last month of the year, as compared with the prior year. A significant number of credit memos for returned merchandise that were issued during the last month of the year were not recorded. Year-end purchases of inventory were overstated by incorrectly including items received in the first month of the subsequent year. Year-end purchases of inventory were understated by incorrectly excluding items received before year-end. Sales increased by a greater percentage than costs of goods sold increased, as compared with the prior year. Sales increased by a lower percentage than costs of goods sold increased, as compared with the prior year. Interest expense decreased, as compared with the prior year. Short-term borrowing was refinanced on a long-term basis at the same interest rate. Short-term borrowing was refinanced on a long-term basis at lower interest rates. Short-term borrowing was refinanced on a long-term basis at higher interest rates. A large percentage of sales occurred during the last month of the year, as compared with the prior year. A smaller percentage of sales occurred during the last month of the year, as compared with the prior year. Appendix A The Free Manufacturing Corporation Summary of Property, Plant, and Equipment and Accumulated Depreciation - Client Prepared December 31, X2 Assets Account Number Description Balance 12/31/X1 151 Land Accumulated Depreciation Balance Addition s Retirement s 500,000 Metho d Rate 12/31/X2 Balance Balance 12/31/X1 Provision Retirement s 12/31/X2 13,500 7,000 20,500 292,000 142,420 434,420 235,000 70,600 305,600 540,500 220,020 666,000 166,000 152-3 Land Improvements 135,000 145,000 S/L 5% 4,995,000 S/L 3% 850,000 S/L 10% 10,000 154-5 Buildings 156-7 Equipment 4,500,000 495,000 800,000 60,000 110,000 Totals 60,000 5,935,000 781,000 6,656,000 760,520