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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.

5) Merchandise traded in the open market is recorded in the company’s records at \)1.40 per unit on December 31, 2017. This price had prevailed for 2 weeks, after release of an official market report that predicted vastly enlarged supplies; however, no purchases were made at \(1.40. The price throughout the preceding year had been about \)2, which was the level experienced over several years. On January 18, 2018, the price returned to $2, after public disclosure of an error in the official calculations of the prior December, correction of which destroyed the expectations of excessive supplies. Inventory at December 31, 2017, was on a lower-of-LIFO-cost-or-market basis.

Instructions

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

Short Answer

Expert verified

The market value should be changed from $2.00 to $1.40.

Step by step solution

01

Meaning of LIFO

LIFO is an inventory valuation method in which the last item is sold first. LIFO is not adopted by every business enterprise because at the end of the year items become old and lose value over time.

02

Explaining the effect in the financial statements

Apply the low-cost-or-market principle to the inventory amount as of December 31, 2017, requiring a market value of $2.00 instead of $1.40. The actual estimate was a temporary error, and no purchases were made at that price.

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Most popular questions from this chapter

(Disclosure of Estimates) Nancy Tercek, the financial vice president, and Margaret Lilly, the controller, of Romine Manufacturing Company are reviewing the financial ratios of the company for the years 2017 and 2018. The financial vice president notes that the profit margin on sales ratio has increased from 6% to 12%, a hefty gain for the 2-year period. Tercek is in the process of issuing a media release that emphasizes the efficiency of Romine Manufacturing in controlling cost. Margaret Lilly knows that the difference in ratios is due primarily to an earlier company decision to reduce the estimates of warranty and bad debt expense for 2018. The controller, not sure of her supervisor’s motives, hesitates to suggest to Tercek that the company’s improvement is unrelated to efficiency in controlling cost. To complicate matters, the media release is scheduled in a few days.

Instructions

  1. Should Lilly, the controller, remain silent? Give reasons.

Answer each of the questions in the following unrelated situations.

a) The current ratio of a company is 5:1 and its acid-test ratio is 1:1. If the inventories and prepaid items amount to $500,000, what is the amount of current liabilities?

Edna Millay Inc. is a manufacturer of electronic components and accessories with total assets of $20,000,000. Selected financial ratios for Millay and the industry averages for firms of similar size are presented below.

Edna Millay

2017 Industry

2015

2016

2017

Averages

Current ratio

2.09

2.27

2.51

2.24

Quick ratio

1.15

1.12

1.19

1.22

Inventory turnover

2.40

2.18

2.02

3.50

Net sales to stockholders’ equity

2.71

2.80

2.99

2.85

Return on common stockholders’ equity

0.14

0.15

0.17

0.11

Total liabilities to stockholders’ equity

1.41

1.37

1.44

0.95

Millay is being reviewed by several entities whose interests vary, and the company’s financial ratios are a part of the data being considered. Each of the parties listed below must recommend an action based on its evaluation of Millay’s financial position.

Archibald MacLeish Bank. The bank is processing Millay’s application for a new 5-year term note. Archibald MacLeish has been Millay’s banker for several years but must reevaluate the company’s financial position for each major transaction.

Robert Penn Warren. A brokerage firm specializing in the stock of electronics firms that are sold over-the-counter, Robert Penn Warren must decide if it will include Millay in a new fund being established for sale to Robert Penn Warren’s clients.

Working Capital Management Committee. This is a committee of Millay’s management personnel chaired by the chief operating officer. The committee is charged with the responsibility of periodically reviewing the company’s working capital position, comparing actual data against budgets, and recommending changes in strategy as needed.

Instructions

b) For each of the four entities, identify two financial ratios, from the ratios presented above that would be most valuable as a basis for its decision regarding Millay.

(Ratio Computations and Additional Analysis) Bradburn Corporation was formed 5 years ago through a public subscription of common stock. Daniel Brown, who owns 15% of the common stock, was one of the organizers of Bradburn and is its current president. The company has been successful, but it currently is experiencing a shortage of funds. On June 10, 2018, Daniel Brown approached the Topeka National Bank, asking for a 24-month extension on two \(35,000 notes, which are due on June 30, 2018, and September 30, 2018. Another note of \)6,000 is due on March 31, 2019, but he expects no difficulty in paying this note on its due date. Brown explained that Bradburn’s cash flow problems are due primarily to the company’s desire to finance a \(300,000 plant expansion over the next 2 fiscal years through internally generated funds. The commercial loan officer of Topeka National Bank requested the following financial reports for the last 2 fiscal years

BRADBURN CORPORATION

BALANCE SHEET

MARCH 31

Assets

2018

2017

Cash

\) 18,200

\( 12,500

Notes receivable

148,000

132,000

Accounts receivable (net)

131,800

125,500

Inventories (at cost)

105,000

50,000

Plant & Equipment (net of depreciation)

1,449,000

1,420,500

Total assets

\)1,852,000

\(1,740,500

Liabilities and Stockholders’ Equity

Accounts payable

\) 79,000

\( 91,000

Notes payable

76,000

61,500

Accrued liabilities

9,000

6,000

Common stock (130,000 shares, \)10 par)

1,300,000

1,300,000

Retained earnings*

388,000

282,000

Total liabilities and stockholders’ equity

\(1,852,000

\)1,740,500

*Cash dividends were paid at the rate of \(1 per share in the fiscal year 2017 and \)2 per share in the fiscal year 2018.

BRADBURN CORPORATION

INCOME STATEMENT

FOR THE FISCAL YEARS ENDED MARCH 31

2018

2017

Sales revenue

\(3,000,000

\)2,700,000

Cost of goods sold*

1,530,000

1,425,000

Gross margin

1,470,000

1,275,000

Operating expenses

860,000

780,000

Income before income taxes

610,000

495,000

Income taxes (40%)

244,000

198,000

Net income

\( 366,000

\) 297,000

Depreciation charges on the plant and equipment of \(100,000 and \)102,500 for fiscal years ended March 31, 2017, and 2018, respectively, are included in the cost of goods sold.

Instructions

A. Compute the following items for Bradburn Corporation.

4) Return on assets for fiscal years 2017 and 2018. (Assume total assets

were $1,688,500 at 3/31/16.)

What is the full disclosure principle in accounting? Why has disclosure increased substantially in the last 10 years?

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