Question

Dave Wooden started Wooden Corporation in 1998 as a small consulting company specializing in streamlining and improving grocery store displays and related inventory configurations.The company has been very successful in improving client ‘bottom lines’ through the use of cutting edge technology to generate fairly accurate information on current consumer trends and opportunities and providing end-results utilizing highly-creative innovations specific to each client.Currently, the company provides these services to a multitude of entities ranging from small, local concerns to some larger, nationally recognized chains.The company itself is a closely held entity with Dave serving as the majority stockholder and president along with a handful of other, unrelated smaller investors.Overall company strategy and primary customer contact is driven by Dave with daily operational activities being led by Dave’s oldest son, Donnie.All remaining activities (primarily administrative and marketing) are guided by Dave’s wife, Sarah. Both Donnie and Sarah each supervise staffs of approximately five individuals that perform the majority of the day-to-day work-load.

Dave (a long-time friend) has recently reached out to you (a licensed CPA in public practice) to “take a look” at the some of the financial information of Wooden Corporation for the year ended 2016. Your analysis will result in the preparation, in proper form, of an unaudited Classified Balance Sheet to be used as supporting documentation in an application for a long-term loan to be used for future growth.

Johnny Gilmer, the internal accountant for Wooden who maintains the company’s financial records, has prepared all the tax returns and financial information for the corporation since January 2, 2010. Gilmer provides you with a Recap of Financial Position providing the information listed below:

Wooden Corporation

Recap of Financial Position (unaudited)

December 31, 2016

ASSETS

Current Assets - 1,823,130

Other Assets - 6,678,700

Total Assets - 8,501,830

An Analysis of Current Assets discloses the following:

Cash and Cash Equivalents - 1,113,195

Investments in Land - 106,500

Accounts Receivable less allowance of $48,000 - 118,710

Inventories (LIFO flow assumption) - 484,725

Total Current assets - 1,823,130

Other Assets include:

Prepaid Insurance 47,073

Buildings (less Accumulated Depreciation of $1,506,310) - 5,123,490

Cash surrender value of life insurance policy - 90,198

Unamortized bond discount - 45,830

Claim for Income Tax Refund - 182,148

Equipment (less Accumulated Depreciation of $153,724) - 642,861

Vehicles (less Accumulated Depreciation of $68,833) - 547,100

Totals 6,678,700

LIABILITIES AND EQUITY

Current Liabilities - 2,450,465

Long-term Liabilities - 1,500,000

Owners Equity - 4,551,365

Total Liabilities and Equity - 8,501,830

Current Liabilities Include:

Accounts Payable - 480,000

Notes Payable (due 2019) - 1,682,213

Income Taxes Payable - 150,000

Premium on Common Stock - 138,252

Totals - 2,450,465

Long-Term Liabilities and Equity Include:

Retained Earnings - 4,551,365

Capital Stock ($10 par, 200,000 authorized, 150,000 issued) - 1,500,000

Totals - 6,051,365

After a preliminary review of the above information, you approach Dave and Johnny with several questions for clarification and the subsequent discussion revealed the following:

*On May 1, 2016, the corporation issued $750,000 of bonds to finance future plant expansion. The proceeds are included in Cash and Cash Equivalents. The long-term bond agreement provided for the annual payment of principal and interest over five years. As of the 2016 year-end, interest due on the bonds has not been recognized in the financial statements.

*In 2013, the ending inventory was overstated by $183,000. The ending inventories for 2014, 2015, and 2016 were correctly computed.

*Insurance amounting to $100,000 was purchased during the year and was expensed when purchased, leaving the balance of prepaid insurance unchanged from the beginning of the period. The balance of unused insurance at the end of 2016 totaled $52,000.

*The Claim for Income Tax Refund stemmed from a Net Operating Loss in 2015 that was carried back to a prior year (2013) and was used to offset income for that year resulting in a refund. The returns were prepared by Gilmer and the carryback appropriately followed Federal Tax guidelines.

*In accordance with GAAP, the Premium on Common Stock represents amounts that all stockholders’ paid in excess of the par value of the stock.

*Income Taxes Payable are the estimated amounts due for 2016 earnings.

*The balance in Accounts Receivable includes a $25,000 balance owed by a particular customer that has signed a written agreement to pay the amount in monthly installments over the next two years with interest. The first payment was made on December 31, 2016 and was recorded as a debit to Cash with a credit to Accounts Receivable for the entire amount (principle and interest). Gilmer plans to adjust Accounts Receivable when the amount is fully paid to recognize interest income at that time and honestly believes that the entire amount will be collected. This way, the adjustment for income will be easy to make since the balance in the account will be equal to the amount of total interest paid. The customer has a record of filing for bankruptcy from time to time.

*In 2016, wages in the amount of $33,000 were not appropriately accrued and were therefore omitted from the balance sheet and not charged to the income statement.

*In 2015, the company replaced the roof on the Administrative building at a cost of $280,000. The replacement was completed in phases over a five month period, paying roughly 20% of the total cost each month. When the roof was replaced, the composition of the roof was changed from an asphalt shingle roof to a clay tile roof for both aesthetic value and to increase the life expectancy. To simplify accounting, the entire amount was expensed as a repair.

*A major competitor has introduced a line of products that will compete directly with Warren’s primary line, now being produced is a specially designed new plant. Because of manufacturing innovations, the competitor’s line will be of comparable quality but priced 50% below the client’s line. The competitor will meet the lower prices that are high enough to cover variable manufacturing and selling expenses, but permit recovery of only a portion of fixed costs.

*The Investment in Land was for the current Administrative Building. The company plans to use the proceeds from the current note application to acquire additional land and begin construction on a new building sometime after 2020.

*In 2016, a gain of $150,000 (net of tax) on the sale of certain plant assets was credited directly to retained earnings.

*Dave refused to release any other information or documentation to you stating the information was proprietary in nature that release of the information would compromise the company’s long-range plans. Therefore, you have all you need to prepare the unaudited Classified Balance Sheet. In addition, Dave has made it very clear that approval of the loan is critical to expand the business and he would pay ‘what-ever is necessary’ for you to produce a document that will assist in the approval.

REQUIREMENTS

Discuss in detail any issues and discrepancies along with the impact on the 2016 year-end unaudited Classified Balance Sheet – you do not need to prepare any financial statements, just analyze the ramifications of the items discussed above.Please discuss each item separately.Your discussion must be at least two pages in length and no more than four pages.Again, you do not need to perform any calculations, just describe the nature if the issue and its effect on Wooden’s financial statements.

Answer 1

1. May 1,2016 $ 750000 Bond issue
The debit side of the entry is proper
ie. The Journal entry should be
Cash	704170
Discount on bonds payable	45830
Bonds Payable		750000

& Bonds payable should be shown on the liabilities-side ,as a separate line-item & not to be combined with equity the balance sheet as follows:

Long term Liabilities:
Bonds Payable	750000
Less: Unamortised Bond discount	45830
Bonds Payable, net		704170
Year-end interest due must be accrued with the entry
Interest expense
Interest payable(to be carried under current liabilities)
so that expenses & liabilities presented are true & fair.

2. Overstatement of ending inventory in 2013 would have led to increased net income & more tax in 2013 , but would have been compensated by decreased net income in & lesser tax in 2014.Though in error in principle, would have been nullified by end of 2014

3.Prepaid Insurance used & expired must be expensed in the income statement of the period for which the insurance paid in advance was used--by a reversal journal entry:

Insurance expense	95073
Prepaid Insurance		95073
(47073+100000-52000)
so that expenses & current assets carried are true & fair.

4. Carryback appropriately followed Federal Tax guidelines.

5.Premium on common stock should be carried under the heading Stockholders' equity --as Paid-in capital in-excess of par-Common stock --on the liabilities side of the Balance sheet & not under Current Liabilities

6.Properly presented --Income Taxes Payable are the estimated amounts due for 2016 earnings.

7.The entire $ 25000 should be transferred from Accounts receivable a/c to a (distinguishable )separate receivable (like Note receivable)& accounted along with the total interest receivable. Every payment received must be segregated towards principal & interest income & credit/debit respectively must be accounted.

This will help the officer to know at a glance , the latest position about such an agreement & also easy for follow up , as the customer is also prone to default.

8. Wages expense	33000
Wages payable		33000
to be passed ,
so that expenses & liabilities presented are true & fair.

9. Replacement of Roof in 2015

As the expenditure also increases the life expectancy of the entire roofing(apart from aesthetics), it must be written off ,over a period of time, covering future accounting years.

Expensing in 1 year has the effect of lowering taxable income & the income tax amount to be paid--which is not acceptable as per GAAP.

10.Not relevant to the current analysis& nothing much can be done about competitor's innovations, except to research ways to counter it ,in future.

11. Investment in Land to be classified as a (long-term) fixed asset ,on the asset side of the balance sheet.

12. The gain should pass through the Income statement only, as it is an operating(above the line) income , & will go ti increase EPS & cannot go to Retained Earnings directly.

13.Dave is bound to produce documents as needed for successful processing of the application for a long-term loan , for his own good.