Question

Simpson Corp. is an entertainment firm that derives approximately 30% of its income from the Casino Knights Division, which manages gambling facilities. As an auditor for Simpson Corp., you have recently overheard the following discussion between the controller and financial vice president.

Vice President: If we sell the Casino Knights Division, it seems ridiculous to segregate the results of the sale in the income statement. Separate categories tend to be absurd and confusing to the stockholders. I believe that we should simply report the gain on the sale as other income or expense without detail.

Controller: Professional pronouncements would require that we report this information separately in the income statement. If a sale of this type is considered unusual and infrequent, it must be reported separate from income from continuing operations.

Vice President: What about the walkout we had last month when employees were upset about their commission income? Would this situation not also be subject to reporting outside operating income?

Controller: I am not sure whether this item should get special reporting or not.

Vice President: Oh well, it doesn’t make any difference because the net effect of all these items is immaterial, so no disclosure is necessary.

Instructions

1. On the basis of the foregoing discussion, answer the following questions. Who is correct about handling the sale? What would be the correct income statement presentation for the sale of the Casino Knights Division?
2. How should the walkout by the employees be reported?
3. What do you think about the vice president’s observation of materiality?
4. What are the earnings per share implications of these topics?

Short answer

Both controller and vice president are correctly handling the sales.

Step-by-step solution

Meaning of Sales

The term sales refer to the transfer of ownership of goods from one party to another. In this process, the sellertransfers the ownership of goods or services in favor of the buyer for a pre-determined consideration price.

Correct handling of sales

According to the situation mentioned above, both the vice president and controller are correct in handling the sales. Both are correct because they are looking at the problem from their point of view. Losing customers will affect the sales, and incorrect reporting will impact the stakeholders.

Hence, the controller and vice president’s perception is correct in this case.

Employees’ walkout reporting

The primary cause of employees’ walkout is poor salesresulting in low revenuegeneration. As the company is generating fewer profits, employees are not able to receive the desired commission.

Hence, the company should disclose losses from employees’ walkouts in the unusual or infrequent section of theincome statement.

Observation of vice president

The vice president’s observation of materialityis incorrect in the given scenario because, according to him, the net effect of all the items is immaterial.

On the other hand, the inaccurate reporting in the income statement will have a material impact on the stakeholders and other users of financial information.

Earnings per share implications

According to the given conversation between the controller and the vice president, if the said issue is disclosed in the income statement, the earnings per share will reflect the decreased amount. If the same is not disclosed, then earnings per share will show an inaccurate figure.