Beth Clark is an Accounting Manager at Specialty Products Corp. One afternoon in early January 2012, her boss, Controller Dan Greene, met with her and stated the following, “Beth, I want you to take another look at our allowance for uncollectible accounts. I think we are over-reserved and that last year’s percentages for uncollectible accounts are too conservative. Here are the revised percentages I want you to use. Also, the Sales Department has reissued an invoice to Titan Industries for their $153,000 account balance. The new invoice is dated December 31, so you will need to change your aging schedule.” Titan Industries was a problem customer, and Beth had heard from some employees in the Credit Department that Titan was in serious financial trouble. Titan’s $153,000 account balance resulted from a sale made in early June 2011.
Beth was immediately troubled by the requests from Dan. Specialty Products was suffering from an unexpected downturn in the 4th quarter as orders from many of their customers were much lower than last year. When she expressed her apprehensions to Dan, he replied, “Don’t worry about the new percentages. Those amounts aren’t material. Besides, our receivables are down and our prepare-off’s of receivables were less than last year. Also, as we discussed in our staff meeting, we need to be on the lookout for any changes we can make to boost our bottom line. The CFO is adamant about hitting the analysts’ estimate for EPS this year. We all have a lot riding on that number.”
The following customer balance totals were extracted from Specialty’s Accounts Receivable Aging report (before the Titan Industries adjustment proposed by Dan Greene):
current accounts $ 6,200,000 $ 5,600,000
past due: 1-30 days 3,800,000 4,200,000
31-60 days 800,000 360,000
61-90 days 500,000 240,000
> 90 days 180,000 160,000
The following are the percentages used by Specialty for the past three years to estimate uncollectible accounts and those proposed by Dan Greene:
Historical Proposed by Dan
Current accounts 3.3% 3.1%
past due: 1-30 days 7.3% 6.8%
31-60 days 10.8% 9.2%
61-90 days 22.0% 19.0%
> 90 days 56.0% 80.0%
a.) Assuming the adjustment for bad debt expense has not yet been made and that the allowance for uncollectible accounts currently has a credit balance of $94,000, what journal entry should Beth make to record the year-end adjustment?
b.) What is the pre-tax impact of the changes requested by Dan Greene? Do you think his changes are appropriate? describe.
c.) As noted above, Beth felt troubled by Dan’s requests. describe Beth’s ethical dilemma. What course of action should she take?
Pat Clark is the controller for Best Pharma, a publicly-held pharmaceuticals manufacturer in Wilmington, Delaware. In early December 2011, Pat’s boss, CEO Bernie Skilling, approached her with the following news: “I’ve come up with an idea for improving our results for this year. My golfing buddy is the CEO of Wright Drugs. His company owns the identical chemical analysis machine which we purchased last year. He is willing to exchange his machine for ours, and since the fair value of our machine is as high as it is, we should be able to book a significant gain on the exchange. I want you to prepare an analysis of how much we will be able to record and how the transaction will affect our financial statements. Remember, we need this deal to improve our pretax income by at least $500,000.”
The chemical analysis machine to which Bernie referred had just recently been invented and was purchased by Best Pharma at the beginning of 2010. The machine was in great demand as soon as it was marketed, but recently many companies have not been able to acquire this model due to long production backlogs and the manufacturer’s involvement in a patent dispute with its inventor. As a result, the resale value of this model has skyrocketed, approaching the amount Best Pharma originally paid for the machine in some cases.
After Bernie left, Pat gathered the following information:
For Best Pharma’s machine:
Historical cost 1,750,000
Accumulated depreciation (as of the date of the
proposed exchange in Dec. 2009) (725,000)
Fair value 1,650,000
(Note: Wright Drugs machine is the exact model in the same condition, so fair value of its machine is identical to Best Pharma’s machine.)
a.) Based on Pat’s information above, what journal entry (or entries), if any, should Pat propose regarding the exchange with Wright Drugs? describe your answer.
b.) Regardless of your answer in part a, if Pat were to conclude that recording a gain of at least $500,000 is not appropriate for this exchange, what course of action should she take? Should she still record the gain according to Bernie’s request? describe.
Wright Co. provides consulting and testing services for the biotechnology industry. In performing these services, Wright makes use of several patents it has purchased from their original developers. One such patent, Patent X, was purchased in 2009, for $15 million. At the time of its purchase, Patent X had a remaining legal life of 18 years, but Wright estimated that its useful life would be 10 years with no residual value. Wright amortizes its intangible assets using the straight-line method.
In late November 2011, at a meeting of its management team, one of Wright’s product managers informed the team that the line of business which relied on the use of Patent X was being threatened by the emergence of a new technology. This new technology will make the process which depended on Patent X much less practical. Further, he estimated that Wright would need to discontinue its services in this area by the end of 2013.
Jane Jones, Wright’s Manager of Financial Reporting, was present at this meeting. Immediately, she became concerned about Wright’s accounting treatment for Patent X. Over the next several weeks, she gathered the following information. As of the end of December, she estimated that the undiscounted net future cash flows of the patent will be approximately $3,500,000 and the fair value of the patent is $2,150,000. However, the personnel familiar with the patent all agreed that Patent X would have little or no value by the end of 2013.
Jane presented the results of her research to Wright’s CFO, Bernie Skilling. Bernie was alarmed by what Jane reported. Wright was finishing up a very disappointing fourth quarter and he was not looking forward to December 31 and the preparation of Wright’s financial statements. In fact, he had just returned from a meeting with the CEO in which they tried to identify ways to improve Wright’s results. The CEO warned that he must look for every opportunity to make the ‘bottom line’ look better or else the Wall Street analysts would be very disappointed. A downgrade of Wright’s shares seemed very likely.
At the end of their meeting, Bernie said to Jane, “I realize that you have concerns about Patent X. However, I am concerned about us falling short of the analysts’ expectations this year. Perhaps we should just revise our estimate for the useful life of the patent. Let’s assume that we can use it for three more years after this year so that its useful life will end on December 31, 2014. After all, it’s possible that we can use it for another three years, rather than the two years that the product manager is estimating.”
After the meeting, Jane felt very disturbed by the attitude of her boss. His suggestion seemed to be inappropriate and his rationale seemed to be motivated only by the pressure to meet analyst expectations, rather than what is required by GAAP. Wright had not yet recorded amortization for 2011, so she decided to prepare a detailed analysis with her recommendation for appropriately accounting for Patent X as of 12/31/2011.
a.) Determine the appropriate treatment for Patent X for 2011 and prepare the journal entry (or entries) that Jane should propose to the CFO. How does the appropriate treatment compare to the CFO’s suggestion? If there is a difference, show how the CFO’s treatment would affect pre-tax income for 2011. (Be sure provide dollar amounts and to show all of your calculations).
b.) Assuming Jane was to conclude that her boss, the CFO, was incorrect in his guidance about the accounting for Patent X, what ethical dilemma might she face in resolving this issue? describe.