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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Financial Statement Violations of U.S. GAAP The following are the financial statements issued by Allen Corporation for its fiscal year ended October 31, 2019:

Chapter 5, Problem 4P, Financial Statement Violations of U.S. GAAP The following are the financial statements issued by

Notes to Financial Statements:

1. Long-Term Lease. Under the terms of a 5-year, noncancelable lease for a building, Allen is obligated to make annual rental payments of $40,000 in each of the next 4 fiscal years.

2. Pension Plan. Substai1tially all employees are covered by Allen’s defined benefit pension plan. Pension expense is equal to the total of pension benefits accrued and paid to retired employees during the year. Because it is a defined benefit plan that is paid every year, no pension liability exists.

3. Patent. The patent had an estimated remaining life of 10 years at the time of purchase. Allen’s patent was purchased from Apex Corporation on January 1, 2019, for $250,000.

4. Deferred Income Tax Payable. The entire balai1ce in the Deferred Income Tax Payable account arose from tax-exempt municipal bonds that were held during the previous fiscal year, giving rise to a difference between taxable income and reported net earnings for the fiscal year ended October 31, 2019. The deferred liability amount was calculated on the basis of past tax rates.

5. Warrants. On January 1, 2018, one common stock warrant was issued to shareholders of record for each common share owned. An additional share of common stock is to be issued upon exercise of 10 stock warrants and receipt of an amount equal to par value. For the 6 months ended October 31, 2019, the average market value for Allen’s common stock was $5 per share and no warrants had yet been exercised.

6. Contingent Liability. On October 31, 2019, Allen was contingently liable for product warranties in an amount estimated to aggregate $75,000.

Required:

Next Level Review the preceding financial state1nents and related notes. Identify any inclusions or exclusions from them that would be in violation of GAAP, and indicate corrective action to be taken. Do not comment as to format or style. Respond in the following order:

1. Balance sheet

2. Notes

3. Income statement

4. Statement of retained earnings

5. General

To determine

Identify the inclusions or exclusions from the financial statement and related notes that would be violated in GAAP, and indicate the corrective action that are to be taken.

Explanation

American Institute of Certified Public Accountants (AICPA): AICPA is the organization which supports the careers for public accountants, prepares Generally Accepted Auditing Standards (GAAS), and focusses on auditing profession.

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Statement of Retained Earnings:

This is a financial statement that determines the amount of earnings kept by the business as retained earnings at the end of the financial year. This statement shows the retained earnings held by the business at the beginning and at the end of the financial year, amount of net income earned during the year and the amount of dividend declared to the shareholder for the year.

Identify the inclusions or exclusions from the financial statement and related notes that would be violated in GAAP, and indicate the corrective action that are to be taken:

  1. Balance Sheet
  2. Under the balance sheet, the patent must be amortized over the 10-year remaining life. This patent should be amortized using the straight-line method of amortization.
  3. On the balance sheet, the deferred income tax liability should not be shown. Because, the difference between taxable income and accounting income is not a temporary difference however, it is a permanent one.
  4. The gross amount of the accounts receivable should be shown, and its net amount of the allowance for doubtful accounts are also to be shown.
  5. Similarly, the quantity of common shares that are authorized, issued, and outstanding should be disclosed in the equity section of the shareholders.
  6. For the accrual of a contingent loss, the warranty contingency meets two tests, and it should be accrued as a liability and an expense shown on the income statement.
  7. Notes

For long term lease:

  • The lease expense that is shown in the earnings statement is correct. Because, the lease discussed in Note 1 is an operating lease. If this operating lease is treated as a capital lease, then the PV of the future minimum lease payments should be calculated and it should be recorded as an asset and as a liability on the balance sheet.
  • The leased assets cost is to be depreciated over the life of the assets and on the outstanding lease liability, the interest expense should be recognized over the life of the lease.

For Pension plan:

  • In this case, the pension plan is a defined benefit plan, and it is equal to the total benefits accrued and paid to retired employees each year...

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