QUALITATIVE ANALYSIS: (Total Point Value 40) You must complete questions 1, 2 & 3 and any one of the other five listed questions. You can also complete one additional question for extra credit. Please indicate which question is the extra credit one. Please be sure that you are thorough in discussion of these qualitative questions.
1. Below are four independent, material and unrelated situations involving accounting changes. Each change occurs during 2013 before any adjusting or closing entries were prepared. Assume a tax rate of 40% and any tax effects are adjusted through the deferred tax asset or liability account. Discuss and evaluate the type of accounting change, briefly describe any steps that should be taken to appropriately report the situation, if you wish to complete journal entries to document the change, please feel free to do so.
a) On December 31, 2004, Laurie Inc. acquired its office building at a cost of $8,000,000. It has been depreciated on a straight-line basis assuming a useful life of 40 years and no salvage value. Plans were finalized in 2013 to relocate the company headquarters at the end of 2014. The vacated office building will have a salvage value at that time of $2,800,000.
b) At the beginning of 2008, Sam Corp. purchased office equipment at a cost of $1,200,000. Its useful life was estimated to be ten years with no salvage value. The equipment has been depreciated by the sum-of-the-years digits method. On January 1, 2013, the company changed to the straight-line method.
c) John Company changed its inventory cost method to LIFO from FIFO at the beginning of 2013 for both financial statement and income tax purposes. Under FIFO, the inventory at January 1, 2013 was estimated to be $15 million. A LIFO reserve at the end of 2013 was calculated to be $706,000.
d) Karl Inc. introduced a new line of auto covers in 2012 that carry a one-year warranty against manufacturer’s defects. Based on industry experience, warranty costs are expected to approximate 4% of sales. Sales of the covers in 2012 were $1,500,000. Warranty expense and warranty liability of $60,000 was recorded in 2012. In late 2013, the company’s claims experience was evaluated and it was determined that claims were far fewer than expected and 3% rather than 4% was recommended. Sales of the covers in 2013 amounted to $3,200,000 and warranty expenditures in 2013 totaled $72,000.
2. On July 1, 2013, Dynamic Corporation purchased for cash 40% of the outstanding capital stock of Cart Company. Dynamic has a fiscal year end of October 31st and Cart has a fiscal year end of March 31st. On October 31st, it has not yet been determined by Dynamic conclusively whether it has the ability to significantly influence Cart’s business operation. Cart Company’s stock is actively traded on the NASDAQ exchange reported its net income for the period ended October 31st to Dynamic. Cart also paid cash dividends on September 15th and December 15th to Dynamic and its other stockholders. How should Dynamic report the above facts in its October 31, 2013 financial statements. Discuss the rationale for your answer.
3. You are the independent accountant assigned to the audit of Sara Company. The company’s accountant, a fellow graduate of the accounting program you attended has prepared financial statements, which contained the following items:
a) The balance sheet reports land at $100,000. Included in this amount is a piece of property purchased for a future warehouse site at a cost of $30,000 and a speculative land investment at a cost of $50,000.
b) Current liabilities include $50,000 for long term debt that comes due in three months. The company has received a suitable firm commitment to refinance the debt for five years and intends to do so.
c) Investments in marketable securities include $20,000 in short-term high-grade commercial paper which the company states is cash.
Discuss the appropriate classification of the above items and how they should be disclosed in a financial statement.
4. Discuss how the terrorist attacks of September 11, 2001 might have affected the impairment of operational assets for an aircraft manufacturer?
5. Why do companies find the issuance of convertible bonds to be an attractive form of financing? Explain the rationale for this statement.
6. What is the justification for a corporation determining income for financial reporting purposes differently than the way it is determined for tax purposes?
7. Explain what is meant by a subsequent event. Give two examples of a subsequent event and discuss how disclosure of such an item would be beneficial to a general user of a financial statement.
8. Carpenter Company is being sued for $2,000,000 for an injury caused to a child as a result of alleged negligence while the child was visiting the Carpenter plant in March 2013. The suit was filed in July 2013. Carpenter’s lawyer states that it is probable that Carpenter will lose the suit and be found liable for a judgment costing anywhere from $200,000 to $900,000. The lawyer also states that the most probable judgment is somewhere around $400,000. Management of Carpenter is strongly opposed to disclosing this event within their financial statements. What would you recommend to your client Carpenter as to reporting the suit in its 2013 financial statements? Discuss the rationale for your answer. Also include any disclosures, if necessary, that should be made in the financial statements