Case 23.2 – An Ethical Dilemma

Scenario:  Beta Computers is experiencing financial difficulties attributed to declining sales of its mainframe computer systems. Several years ago, the company obtained a large loan from Midland State Bank. The covenants of the loan agreement strictly state that if Beta is unable to maintain a current ratio of 3:1, a quick ratio of 1:1, and a return on assets of 12 percent, the bank will exercise its right to liquidate the company’s assets in settlement of the loan. To monitor Beta’s performance, the bank demands quarterly financial statements that have been reviewed by an independent CPA.

Nick Price, Beta’s CEO, has just reviewed the company’s master budget projections for the first two quarters of the current year. What he has learned is disturbing. If sales trends continue, it appears that Beta will be in violation of its loan covenants by the end of the second quarter. If these projections are correct, the bank might foreclose on the company’s assets. As a consequence, Beta’s 750 employees will join the ranks of the unemployed.

In February of the current year, Rembrant International contacted Beta to inquire about purchasing a custom-configured mainframe computer system. Not only would the sale generate over a million dollars in revenue, it would put Beta back in compliance with its loan covenants. Unfortunately, Rembrant International is an extremely bad credit risk, and the likelihood of collecting on the sale is slim. Nonetheless, Nick Price approved the sale on February 1, which resulted in the recording of a $1.4 million receivable.

On March 31, Edgar Gamm, CPA, arrived at Beta’s headquarters. In Gamm’s opinion, the $1.4 million receivable from Rembrant International should immediately be written off as uncollectible. Of course, if the account is written off, Beta will be in violation of its loan covenants and the bank will soon foreclose. Gamm told Price that it is his professional duty to prevent any material misstatement of the company’s assets.

Price reminded Gamm that if the account is written off, 750 employees will be out of work, and that Gamm’s accounting firm probably could not collect its fee for this engagement. Price then showed Gamm Beta’s master budget for the third and fourth quarters of the current year. The budget indicated a complete turnaround for the company. Gamm suspected, however, that most of the budget’s estimates were overly optimistic.

Initial Post – As an employee, write an internal memo to your manager addressing the following:

Should Gamm insist that the Rembrant International account be classified as uncollectible? Should the optimistic third and fourth quarter master budget projections influence his decision? What would you do if you were in his position? Defend your actions.

If you were the president of Midland State Bank, what would you do if you discovered that the Rembrant International account constituted a large portion of Beta’s reported liquid assets and sales activity for the quarter? How would you react if Edgar Gamm’s accounting firm had permitted Beta to classify the account as collectible?

Roth Contractors Corporation was incorporated on December 1, 2019 and had the following transactions during December: Part A a. Issued common stock for $5,000 cash b. Paid $1,200 cash for three months’ rent: December 2019; January and February 2020 c. Purchased a used truck for $10,000 on credit (recorded as an account payable) d. Purchased $1,000 of supplies on credit. These are expected to be used during the month (recorded as expense) e. Paid $1,800 for a one-year truck insurance policy, effective December 1 f. Billed a customer $4,500 for work completed to date g. Collected $800 for work completed to date h. Paid the following expenses in cash: advertising, $350; interest, $100; telephone, $75; truck operating, $425; wages, $2,500 i. Collected $2,000 of the amount billed in f above j. Billed customers $6,500 for work completed to date k. Signed a $9,000 contract for work to be performed in January 2020 l. Paid the following expenses in cash: advertising, $200; interest, $150; truck operating, $375; wages, $2,500 m. Collected a $2,000 advance on work to be done in January (the policy of the corporation is to record such advances as revenue at the time they are received) n. Received a bill for $100 for electricity used during the month (recorded as utilities expense). Required: 1. Open general ledger T-accounts for the following: Cash, Accounts Receivable, Prepaid Insurance, Prepaid Rent, Truck, Accounts Payable, Common Stock, Repair Revenue, Advertising Expense, Interest Expense, Supplies Expense, Telephone Expense, Truck Operating Expense, Utilities Expense, and Wages Expense. General ledger account numbers are not necessary. 2. Prepare journal entries to record the December transactions. General ledger account numbers and descriptions are not needed. 3. Post the entries to general ledger T-accounts. Part B The following information relates to December 31, 2019: o. One month of the prepaid insurance has expired. p. The December portion of the rent paid on December 1 has expired. q. A physical count indicates that $350 of supplies is still on hand. r. The amount collected in transaction m is unearned at December 31. s. Three days of wages for December 29, 30, and 31 are unpaid, amounting to $1,500. These will be paid in January. t. The truck has an estimated useful life of 4 years. u. Income taxes expense is $500. This amount will be paid in the next fiscal year. Required: 4. Open additional general ledger T-accounts for the following: Unused Supplies, Accumulated Depreciation, Wages Payable, Unearned Revenue, Income Taxes Payable, Depreciation Expense, Insurance Expense, Rent Expense, and Income Taxes Expense. General ledger account numbers are not necessary. 5. Prepare all necessary adjusting entries. General ledger account numbers and descriptions are not necessary. 6. Post the entries to general ledger T-accounts and calculate balances. 7. Prepare an adjusted trial balance at December 31. 8. Assume the fiscal year-end is December 31, 2019. Prepare an income statement, statement of changes in equity, and balance sheet. 9. Prepare closing entries and a post-closing trial balance at December 31, 2019.

On January 1, 2019, the general ledger of a company includes the following account balances:

The company accounts for all inventory transactions using the perpetual FIFO method. Purchases and sales of inventory are recorded using the gross method for cash discounts. The $36,000 beginning balance of inventory consists of 400 units, each costing $90. During January 2019, the company had the following transactions:

During January 2019, the following transactions occur:

The following information is available on January 31, 2019.

1. Of the remaining accounts receivable, the company estimates that 10% will not be collected.
2. Accrued interest income on notes receivable for January.
3. Accrued interest expense on notes payable for January.
4. Accrued income taxes at the end of January for $5,600.
5. Depreciation on the building, $2,600.

Need help with recording transactions

In January 2018, Dunder Mifflin Inc. bought property in downtown Scranton. The property contains land, a warehouse, and some limited equipment. Property values in the area have been increasing rapidly over the past decade. The price paid for the property needs to be allocated to the items purchased and the controller and financial vice president are having that discussion. Dunder Mifflen’s controller wants to allocate the largest proportion of the cost to the warehouse and equipment while the financial VP, David Wallace, argues that the allocation should recognize the steadily increasing value of the land by allocating the highest value to the land. Assume that the same depreciation methods are used for financial and tax return purposes.

1. Under generally accepted accounting principles, how should the total cost of the property be determined?
2. Why is there any question about how much of the purchase cost should be allocated to each of the assets? How should the purchase cost be allocated to each of the assets?
3. What are the pros and cons of a proportionally higher allocation of the purchase cost to the land and a proportionally lower allocation to building and equipment?
4. Assume the equipment and warehouse have the same useful life. The company plans to sell the equipment after it has been fully depreciated and the land will be sold after the warehouse is fully depreciated. Assuming no change in tax rates over the life of the warehouse, how will this allocation decision affect Retained Earnings in the long-run, after the assets have been sold? Explain in depth. *

Central City, Inc. has incurred a $50,000 loss on property due to an earthquake. Earthquakes have occurred in this region. What amount will be reported for this loss on company's income statement, assuming a 30% tax rate?

A) $50,000

B) $35,000

C) $15,000

D) Zero, due to the fact that this event is infrequent in nature.

Cane Company manufactures two products called Alpha and Beta that sell for $155 and $115, respectively. Each product uses only one type of raw material that costs $6 per pound. The company has the capacity to annually produce 110,000 units of each product. Its unit costs for each product at this level of activity are given below:

The company considers its traceable fixed manufacturing overhead to be avoidable, whereas its common fixed expenses are deemed unavoidable and have been allocated to products based on sales dollars.

11. How many pounds of raw material are needed to make one unit of Alpha and one unit of Beta?

12. What contribution margin per pound of raw material is earned by Alpha and Beta? (Round your answers to 2 decimal places.)

13. Assume that Cane’s customers would buy a maximum of 87,000 units of Alpha and 67,000 units of Beta. Also assume that the company’s raw material available for production is limited to 168,000 pounds. How many units of each product should Cane produce to maximize its profits?

14. Assume that Cane’s customers would buy a maximum of 87,000 units of Alpha and 67,000 units of Beta. Also assume that the company’s raw material available for production is limited to 168,000 pounds. What is the maximum contribution margin Cane Company can earn given the limited quantity of raw materials?

15. Assume that Cane’s customers would buy a maximum of 87,000 units of Alpha and 67,000 units of Beta. Also assume that the company’s raw material available for production is limited to 168,000 pounds. Up to how much should it be willing to pay per pound for additional raw materials? (Round your answer to 2 decimal places.)

1. On July 1, Darin Company sold inventory costing $4,500 to Dee Company for $6,000, terms 2/10, n/30. Both companies use a perpetual inventory system. What journal entry will be recorded by Dee Company on July 1?

A) Debit Purchases and credit Accounts Payable for $6,000

B) Debit Inventory and credit Accounts Receivable for $6,000

C) Debit Inventory and credit Accounts Payable for $6,000

D) Debit Cost of Goods Sold and credit Inventory for $4,500

1. On June 15, Oakley Inc. sells inventory on account to Sunglass Hut (SH) for $1,000, terms 2/10, n/30. On June 20, SH returns to Oakley inventory that SH had purchased for $300. On June 24, SH completely fulfills its obligation to Oakley by making a cash payment. What is the amount of cash paid by SH to Oakley?

A) $680

B) $686

C) $700

D) $1,000

2. Sales revenue equals $367,810, sales returns & allowances are $10,000, and sales discounts total $14,180. The cost of goods sold is $216,490, operating expenses are $28,500, and the company incurs $31,640 of income tax expense. Which of the following statements is correct?

A) Net sales equal $343,630 and gross profit is $98,640.

B) Net sales equal $67,000 and gross profit is $98,640.

C) Net sales equal $343,630 and gross profit is $127,140.

D) Net sales equal $367,810 and gross profit is $67,000.

3. Tony’s Market recorded the following events involving a recent purchase of inventory:

Received goods for $80,000, terms 2/10, n/30.

Returned $1,600 of the shipment for credit.

Paid $400 freight on the shipment.

Paid the invoice within the discount period.

As a result of these events, the company’s inventory

a.   increased by $76,832.

b.   increased by $78,800.

c.   increased by $77,224.

d.   increased by $77,232.

Cane Company manufactures two products called Alpha and Beta that sell for $155 and $115, respectively. Each product uses only one type of raw material that costs $6 per pound. The company has the capacity to annually produce 110,000 units of each product. Its unit costs for each product at this level of activity are given below:

The company considers its traceable fixed manufacturing overhead to be avoidable, whereas its common fixed expenses are deemed unavoidable and have been allocated to products based on sales dollars.

6. Assume that Cane normally produces and sells 97,000 Betas per year. If Cane discontinues the Beta product line, how much will profits increase or decrease?

7. Assume that Cane normally produces and sells 47,000 Betas per year. If Cane discontinues the Beta product line, how much will profits increase or decrease?

8. Assume that Cane normally produces and sells 67,000 Betas and 87,000 Alphas per year. If Cane discontinues the Beta product line, its sales representatives could increase sales of Alpha by 11,000 units. If Cane discontinues the Beta product line, how much would profits increase or decrease?

9. Assume that Cane expects to produce and sell 87,000 Alphas during the current year. A supplier has offered to manufacture and deliver 87,000 Alphas to Cane for a price of $108 per unit. If Cane buys 87,000 units from the supplier instead of making those units, how much will profits increase or decrease?

10. Assume that Cane expects to produce and sell 57,000 Alphas during the current year. A supplier has offered to manufacture and deliver 57,000 Alphas to Cane for a price of $108 per unit. If Cane buys 57,000 units from the supplier instead of making those units, how much will profits increase or decrease?

Coolbrook Company has the following information available for the past year:   

   
The company’s hurdle rate is 8.01 percent.

Required:
1. Calculate return on investment (ROI) and residual income for each division for last year. (Enter your ROI answers as a percentage rounded to two decimal places, (i.e., 0.1234 should be entered as 12.34%.))



2. Recalculate ROI and residual income for each division for each independent situation that follows: (Enter your ROI answers as a percentage rounded to two decimal places, (i.e., 0.1234 should be entered as 12.34%.))

a. Operating income increases by 8 percent.



b. Operating income decreases by 9 percent.



c. The company invests $245,000 in each division, an amount that generates $118,000 additional income per division.



d. Coolbrook changes its hurdle rate to 6.01 percent.

Packaging Solutions Corporation manufactures and sells a wide variety of packaging products. Performance reports are prepared monthly for each department. The planning budget and flexible budget for the Production Department are based on the following formulas, where q is the number of labor-hours worked in a month:

The Production Department planned to work 4,400 labor-hours in March; however, it actually worked 4,200 labor-hours during the month. Its actual costs incurred in March are listed below:

Required:

1. Prepare the Production Department’s planning budget for the month.

2. Prepare the Production Department’s flexible budget for the month.

3. Prepare the Production Department’s flexible budget performance report for March, including both the spending and activity variances.

Answer the following questions:

The launch of a new product is under consideration. Its unit variable costs will be £30 and it is estimated that incremental fixed costs of £250,000 will be incurred if production is commenced. Forecast sales are 50,000 units. If the actual planned selling price is £48 per unit, what will be the organisation’s margin of safety?

The following information is about two organisations, A and B.

Which firm has higher operating gearing?

Which firm is facing more risk in terms of its current sales predictions?

Be sure to demonstrate your numerical workings. Please explain where possible..

Evelyn Walton started Walton Manufacturing Company to make a universal television remote control device that she had invented. The company’s labor force consisted of part-time employees. The following accounting events affected Walton Manufacturing Company during its first year of operation. (Assume that all transactions are cash transactions unless otherwise stated.)

Transactions for January 2018, First Month of Operation

1. Issued common stock for $10,000.

2. Purchased $410 of direct raw materials and $60 of production supplies.

3. Used $385 of direct raw materials.

4. Used 70 direct labor hours; production workers were paid $9.70 per hour.

5. Expected total overhead costs for the year to be $3,000, and direct labor hours used during the year to be 1,000. Calculate an overhead rate and apply the appropriate amount of overhead costs to Work in Process Inventory.

6. Paid $144 for salaries to administrative and sales staff.

7. Paid $22 for indirect manufacturing labor.

8. Paid $215 for rent and utilities on the manufacturing facilities.

9. Started and completed 100 remote controls during the month; all costs were transferred from the Work in Process Inventory account to the Finished Goods Inventory account.

10. Sold 80 remote controls at a price of $21.4 each.

Transactions for Remainder of 2018

11. Acquired an additional $18,000 by issuing common stock.

12. Purchased $3,910 of direct raw materials and $880 of production supplies.

13. Used $3,000 of direct raw materials.

14. Paid production workers $9.70 per hour for 900 hours of work.

15. Applied the appropriate overhead cost to Work in Process Inventory.

16. Paid $1,559 for salaries of administrative and sales staff.

17. Paid $236 of indirect manufacturing labor cost.

18. Paid $2,390 for rental and utility costs on the manufacturing facilities.

19. Transferred 850 additional remote controls that cost $12.74 each from the Work in Process Inventory account to the Finished Goods Inventory account.

20. Determined that $166 of production supplies was on hand at the end of the accounting period.

21. Sold 840 remote controls for $21.40 each.

22. Determine whether the overhead is over- or underapplied. Close the Manufacturing Overhead account to the Cost of Goods Sold account.

23. Close the revenue and expense accounts.

Required

1. For each of the above transactions, post the effects to the appropriate T-accounts.

2. Prepare a schedule of cost of goods manufactured and sold, an income statement, and a balance sheet for 2018.

Your company provides a variety of delivery services. Management wants to know the volume of a particular delivery that would generate $10,000 per month in operating profits before taxes. The company charges $20 per delivery.

The controller’s office has estimated overhead costs at $9,000 per month for fixed costs and $12 per delivery for variable costs. You believe that the company should use regression analysis. Your analysis shows the results to be:

Monthly overhead
=
$
26
,
501
+
$
10.70
 
per delivery
Monthly overhead=$26,501+$10.70 per delivery
Your estimate was based on the following data:

Month Overhead Costs Number of Deliveries
  1 $142,860.                  11,430
  2   151,890                     12,180
  3   192,600.                  15,660
  4   141,030                     11,250
  5   203,490.                   12,780
  6   180,630.                  14,730
  7   159,630                     12,510
  8   183,990                     15,060
  9   194,430.                   15,450
10   150,120                     11,970
11   154,080.                   12,630
12   184,800.                  15,300
13   183,120.                   14,580
The company controller is somewhat surprised that the cost estimates are so different. You have been asked to recheck your work and see if you can figure out the difference between your results and the controller’s results.

Required

Analyze the data and your results and state your reasons for supporting or rejecting your cost equation.

Write a report that informs management about the correct volume that will generate $10,000 per month in operating profits before taxes.

1. National Comapny issued 7.5% bonds, dated January 1, with a face amount of $600,000 on January 1, 2017. The bonds mature on December 31, 2023. The market yield for bonds of similar risk and maturity was 5.5%. Interest is made semiannually on June 30 and December 31.

Required:

a. Determine the price of the bonds at January 1, 2017 (be certain to include all of the "given" information)

b. Prepare a bond amortization table using the effective interest method and make certain to obtain totals for the columns of Cash Interest Paid, Interest Expense, and Premium Amortization

c. Prepare the journal entry to record their issuance by National Company on January 1, 2017.

d. Prepare the journal entry recordin gthe first interest payment on June 30, 2017.

e. Prepare the journal entry recording the interest payment on December 31, 2017.

f. Prepare journal entries at maturity on December 31, 2023.

g. Prepare the journal entry to record the retirement of the bond at a call price of $640,000 on January 1, 2020.

h. Instead of retirement of the bond as described in "g" above, assume the bond was retired @108 call price on January 1, 2020.

Activity-Based Budget

Olympus, Inc., manufactures three models of mattresses: the Sleepeze, the Plushette, and the Ultima. Forecast sales for next year are 15,510 for the Sleepeze, 12,120 for the Plushette, and 5,430 for the Ultima. Gene Dixon, vice president of sales, has provided the following information:

1. Salaries for his office (including himself at $66,650, a marketing research assistant at $44,000, and an administrative assistant at $23,900) are budgeted for $134,550 next year.
2. Depreciation on the offices and equipment is $17,800 per year.
3. Office supplies and other expenses total $20,600 per year.
4. Advertising has been steady at $19,450 per year. However, the Ultima is a new product and will require extensive advertising to educate consumers on the unique features of this high-end mattress. Gene believes the company should spend 15 percent of first-year Ultima sales for a print and television campaign.
5. Commissions on the Sleepeze and Plushette lines are 6 percent of sales. These commissions are paid to independent jobbers who sell the mattresses to retail stores.
6. Last year, shipping for the Sleepeze and Plushette lines averaged $50 per unit sold. Gene expects the Ultima line to ship for $70 per unit sold since this model features a larger mattress.

Suppose that Gene is considering three sales scenarios as follows:

Suppose Gene determines that next year's Sales Division activities include the following:

Research—researching current and future conditions in the industry

Shipping—arranging for shipping of mattresses and handling calls from purchasing agents at retail stores to trace shipments and correct errors

Jobbers—coordinating the efforts of the independent jobbers who sell the mattresses

Basic ads—placing print and television ads for the Sleepeze and Plushette lines

Ultima ads—choosing and working with the advertising agency on the Ultima account

Office management—operating the Sales Division office

The percentage of time spent by each employee of the Sales Division on each of the above activities is given in the following table:

Additional information is as follows:

1. Depreciation on the office equipment belongs to the office management activity.
2. Of the $20,600 for office supplies and other expenses, $5,200 can be assigned to telephone costs which can be split evenly between the shipping and jobbers' activities. An additional $2,300 per year is attributable to Internet connections and fees, and the bulk of these costs (75 percent) are assignable to research. The remainder is a cost of office management. All other office supplies and costs are assigned to the office management activity.

Required:

1. Prepare an activity-based budget for next year by activity. Use the expected level of sales activity. If required, round answers to the nearest dollar.

2. On the basis of the budget prepared in Requirement 1, advise Gene regarding actions that might be taken to reduce expenses.