1. Electric Utility Bills. When an electric utility customer uses electricity, the electric company has earned revenues. It is obviously impossible, however, for the company to read all of its customers' meters on the evening of December 31. How does the electric company know its revenue for a given year? Explain.
2. Retainer Fee. A law firm received a "retainer" of $10,000 on July 1, 2001, from a client. In return, it agreed to furnish general legal advice upon request for one year. In addition, the client would be billed for regular legal services such as representation in litigation. There was no way of knowing how often, or when, the client would request advice, and it was quite possible that no such advice would be requested. How much of the $10,000 should be counted as revenue in 2001? Why?
3. Cruise. Raymond's, a travel agency, chartered a cruise ship for two weeks beginning January
23,2002, for $200,000. In return, the ship's owner agreed to pay all costs of the cruise. In 2001, Raymond's sold all available space on the ship for $260,000. It incurred $40,000 in selling and other costs in doing so. All the $260,000 Was received in cash from passengers in 2001. Raymond's paid $50,000 as an advance payment to the ship owner in 2001. How much, if any, of the $260,000 was revenue to Raymond's in 20017 Why ? Does the question of whether passengers were entitled to a refund in 2002 if they canceled their reservations make any difference in the answer? Why?
4. Accretion. A nursery owner had one plot of land containing Christmas trees that were four years old on November 1, 2001. The owner had incurred costs of $3 per tree up to that time. A wholesaler offered to buy the trees for $4 each and to pay in addition all costs of cutting and bundling, and transporting them to market. The nursery owner declined this offer, deciding that it would be more profitable to let the trees grow' for one more year. Only a trivial amount of additional cost would be involved. The price of Christmas trees varies with the height. Should the nursery owner recognize any revenue from these trees in 2001? Why?
5. "Unbilled" Receivables. The balance sheet of an architectural firm shows a significant asset labeled Unbilled Receivables. The firm says this represents in-process projects, valued the rates at which the customers will be charged for the architects' time. Why would a firm do this instead of valuing projects in process at their cost, the same as a manufacturing firm would value its in-process inventory? Does it make any difference in the reported owners' equity for the architectural firm to report such in-process work as receivables rather than as inventory? Why?
7. Traveler's Checks. A bank sells a customer $500 of American Express traveler's check for which the bank collects, from the customer $505. (The bank charges a 1 percent fee this service.) How does the bank record this transaction? How does the transaction affect American Express's balance sheet?
8. Product Repurchase Agreement. In December 2001 Manufacturer A sold merchandise to Wholesaler' B. B used this inventory as collateral for a bank loan of $100,000 and sent the $100,000 to A. Manufacturer A agreed to repurchase the goods on or before July 1.2002, for $112,000,the difference representing interest on the loan and compensation for B’s services. Does Manufacturer A have revenue in 2001? Why?
2. It is said that the perpetual inventory method identifies the amount of inventory shrinkage from pilferage, spoilage, and the like, an amount that is not revealed by the periodic inventory method. Having identified this shrinkage amount, however, how should it be recorded in the accounts?
3. People have said that the LIFO method assumes that the goods purchased last are sold first. If this is so, the assumption is clearly unrealistic because companies ordinarily sell their oldest merchandise first. Can a method based on such an unrealistic assumption be supported, other than as a tax gimmick?
4. A certain automobile dealer bases its selling prices on the actual invoice cost of each automobile. In a given model year, the invoice cost for similar automobiles may be increased once or twice to reflect increased manufacturing costs. Would this automobile dealer be wrong if it used the LIFO method? By contrast, a certain hardware dealer changes its selling prices whenever the wholesale price of its goods changes as reported in wholesalers' price lists. Would this hardware dealer be wrong if it used the FIFO method?
5. Are the following generalizations valid?
a. The difference between LIFO and FIFO is relatively small if inventory turnover is relatively high.
b. The average cost method will result in net income that is somewhere between that produced by the LIFO method and that produced by the FIFO method.
e. If prices rise in one year and fall by an equal amount the next year, the total income for the two years is the same under the FIFO method as under the LIFO method.
6. If the LIFO method is used and prices are rising, ending inventory will normally be significantly below prevailing market prices. Therefore, what justification is there for applying the lower-of –cost-or-market rule to LIFO inventories?
1. In 2003 a group of female employees sued the company, asserting that their salaries were unjustifiably lower than salaries of men doing comparable work. They asked for back pay of $250,000. A large number of similar suits had been filed in other companies, but results were extremely varied. Norman's outside counsel thought that the company probably would win the suit but pointed out that the decisions thus far were divided, and it was difficult to forecast the outcome. In any event, it was unlikely that the suit would come to trial in 2004. No provision for this loss had been made in the financial statements.
2. The company had a second lawsuit outstanding. It involved a customer who was injured by one of the company's products. The customer asked for $500,000 damages. Based on discussions with the customer's attorney, Norman's attorney believed that the suit probably could be settled for
$50,000. There was no guarantee of this, of course. On the other hand, if the suit went to trial, Norman might win it. Norman did not carry product liability insurance. Norman reported $50,000 as a Reserve for Contingencies, with a corresponding debit to Retained Earnings.
3. In 2003 plant maintenance expenditures were $44,000. Normally, plant maintenance expense was about $60,000 a year, and $60,000 had indeed been budgeted for 2003. Management decided, however, to economize in 2003, even though it was recognized that the amount would probably have to be made up in future years. In view of this, the estimated income statement included an item of $60,000 for plant maintenance expense, with an offsetting credit of $16,000 to a reserve account included as a noncurrent liability.
4. In early January 2003 the company issued a 5 percent $100,000 bond to one of its stockholders
in return for $80,000 cash. The discount of $20,000 arose because the 5 percent interest rate
was below the going interest rate at the time; the stockholder thought that this arrangement provided a personal income tax advantage as compared with an $80,000 bond at the market rate of interest. The company included the $20,000 discount as one of the components of the asset “other deferred charges” on the balance sheet and included the $100,000 as a noncurrent liability. When questioned about this treatment, the financial vice president said, “ I know that other companies may record such a transaction differently, but after all we do owe $100,000. And anyway, what does it matter where the discount appears?”
5. The $20,000 bond discount was reduced by $784 in 2003 and Ms. Warshaw calculated that this was the correct amount of amortization. However, the $784 was included as an item of nonoperating expense on the income statement, rather than being charged directly to Retained Earnings.
6. In connection with the issuance of the $100,000 bond, the company had incurred legal fees amounting to $500. These costs were included in nonoperating expenses in the income statement because, according to the financial vice president, "issuing bonds is an unusual financial transaction for ns, not. a routine operating transaction."
7. On January 2, 2003, the company had leased a new Lincoln Town Car, valued at $35,000, to be used for various official company purposes. After three years of $13,581 annual year-end lease
payments, title to the car would pass to Norman, which expected to use the car through at least year-end 2007. The $13,581 lease payment for 2003 was included in operating expenses in the income statement.
Although Mr. Burrows recognized that some these transactions might affect the provision for income taxes, he decided not to consider the possible tax implications until after he had thought through the appropriate financial accounting treatment.
1. Norman had purchased advertising brochures costing $125,000 in 2003. At the end of 2003, one-fifth of these brochures were on hand; they would be mailed in 2004 to prospective customers who sent in a coupon request for them. As of March 1, 2004, almost all the brochures had been mailed. Norman had charged $100,000 of the cost of these brochures as an expense in 2003, and showed $25,000 as a deferred charge as of December 31, 2003.
2. In 2003 the company had placed magazine advertisements, costing $75,000, offering these brochures. The advertisements had appeared in 2003. Because the sales generated by the brochures would not occur until after prospective customers had received the brochures and placed orders, which would primarily be in 2004, Norman had recorded the full $75,000 as a deferred charge on its December 31, 2003, balance sheet.
3. Norman's long-standing practice was to capitalize the costs of development projects if they were likely to result in successful new products. Upon introduction of the product, these amounts were written off to cost of sales over a five-year period. During 2003 $55.000 had been added to the asset account and $36,000 had been charged off as an expense. Preliminary research efforts were charged to expense, so the amount capitalized was an amount that related to products added to Norman's line. In the majority of instances, these products at least produced some gross profit, and some of them were highly successful.
4. In 2003 the financial vice president decided to capitalize, as a deferred charge, the costs of the company's employee training program, which amounted to $35,000. He had read several books and articles on "human resource accounting'' that advocated such treatment because the value of these training programs would certainly benefit operations in future years.
5. For many years, Norman's practice had been to set its allowance for doubtful accounts at 2
percent of accounts receivable. This amount had been satisfactory. In 2003, however, a customer who owed $19,040 went bankrupt. From inquiries made at local banks, Norman Corporation could obtain no reliable estimate of the amount that eventually could be recovered. The loss might be negligible, and it might be the entire $19,040. The $19,040 was included as an account receivable on the proposed balance sheet.
6. Norman did not carry fire or theft insurance on its automobiles and trucks. Instead, it followed the practice of self-insurance. It charged $5,000 as an expense in 2003, which was the approximate cost of fire and theft insurance policies, and credited this amount to an insurance reserve, a noncurrent liability. During 2003 only one charge, for $3,750, was made to this reserve account, representing the cost of repairing a truck that had been stolen and later recovered. The balance in the reserve account as of January 1, 2003, was $20,900.
7. In 2003 the board of directors voted to sell a parking lot that the company had operated for several years. Another company had expressed an interest in buying the lot for approximately $125,000. In 2003 the pretax income generated by this lot was $19,000. The book value of the assets that would be sold was $50,000 as of the end of 2003. Norman did not reflect this transaction in its financial statements because no final agreement had been reached with the proposed buyer and because the sale would not take place until well into 2004, even if a final agreement was reached in the near future.
8. During 2002 the president of Norman exercised a stock option and the corporation used treasury stock for this purpose. The treasury stock had been acquired several years earlier at a cost of $10.000 and was carried in the shareholders' equity section of the balance sheet at this amount.
In accordance with the terms of the option agreement, tile president paid $13,000 for it. He
immediately sold this stock, however, for $25,000. Norman disregarded the fact that the stock was clearly worth $25,000 and recorded the transaction as:
Cash ...... 13,000
Gain on Treasury Stock . . . 3,000
Treasury Stock ...... 10,000
The $3,000 gain was included as a nonoperating income item on the income statement.
9. Norman's long-standing practice was to declare an annual cash dividend of $50,000 in December and to pay it in January. When the dividend was paid, the following entry was made:
Retained Earnings ...... 50,000
Cash ...... 50,000