Question

At December 31, 2017, Coburn Corp. has assets of \(10,000,000, liabilities of \)6,000,000, common stock of \(2,000,000 (representing 2,000,000 shares of \)1 par common stock), and retained earnings of \(2,000,000. Net sales for the year 2017 were \)18,000,000, and net income was $800,000. As auditors of this company, you are making a review of subsequent events on February 13, 2018, and you find the following.

4) A major electronics enterprise has introduced a line of products that would compete directly with Coburn’s primary line, now being produced in a specially designed new plant. Because of manufacturing innovations, the competitor has been able to achieve quality similar to that of Coburn’s products but at a price 50% lower. Coburn officials say they will meet the lower prices, which are high enough to cover variable manufacturing and selling costs but which permit recovery of only a portion of fixed costs.

Instructions

State in each case how the 2017 financial statements would be affected, if at all.

Short answer

In assessing the appropriate adjustments or disclosures for this transaction, judgment should play an important role.

Step-by-step solution

Meaning of Subsequent event

Any major financial event that occurred after the formal balance sheet date but before the statement was issued should be explained in the notes to the financial statements. These are known as post-balance-sheet events or simply subsequent events.

Explaining the effect in the financial statements

If it is the second type of event that provides evidence of circumstances that did not exist as of December 31, 2017, the required disclosure must state:

a) Plant and inventory expenses are not likely to be recovered.

b) The firm may have to spend more money to modify the existing facility.

c) It is impossible to predict future economic events under this circumstance. (If we can figure out what they are Pro-forma data would be useful.)

The financial statements should be revised if it is a subsequent event for which the position existed as of December 31, 2017. If amounts cannot be estimated, GAAP accounting provisions relating to contingencies will apply. It should be emphasized throughout the class that there is no right answer to this dilemma. In assessing the appropriate adjustments or disclosures for this transaction, judgment should play an important role.