Presented By:Utkarsh Aggarwal(151)

Aatish Mathur(152)
ChandraPrakash(153)
Samridhi Chopra(154)
Shaily(155)
Saurav Jaiswal(156)

Flow Of Presentation
Background

Objectives
Case

analysis
Debt ratios
Summary

Background

Norman Corporation is a young manufacturer

of specialty consumer product.
Until 2010, it had not had its financial
statements audited. It relied on the auditing
firm of Kline & Burrows to prepare its income
tax returns.
Norman decided to have its financial
statements attested by Kline & Burrows
because it was considering borrowing on a
long-term note and the lender surely would
require audited statements.

 Kline

and Burrows assigned Jennifer

Warshaw to do the preliminary work on
the engagement under the direction of
Allen Burrows.

Normans

financial VP had prepared the

preliminary financial statements.

In

examining the information on which

these financial statements were based,
Ms Warshaw discovered several items.
She referred these to Mr. Burrows.

Item 1
In

2010 a group of female employees

sued the company, asserting that there
salaries were unjustifiably lower than
salaries of men doing comparable work.
They asked for backpay of $250,000.
A large number of similar suits have been
filed in other companies, but results were
extremely varied.

 Normans

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 2011. No provision
for this loss has been made in the financial
statements.

Answer
In

order to recognize an expense related

to this contingency, it must be feasible to
make an estimate of at least the minimum
amount of loss. In this case no such
estimate is available, so no amount
should be recorded.

However,

the existence of the suit should

be disclosed in a note to the financial
statements.

Item 2
There

is a second lawsuit outstanding.

It involved a customer who was injured

by one of the companys products and
asked for $ 500,000 damages.

Based

on discussions with customers

attorney, Normans 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.

Answer
A

loss contingency should be recognized.

However, it should be recorded as
expense or loss on the income statement
(not immediately debited to Retained
Earnings)
And a liability on the balance sheet (not
a Reserve for Contingencies)
operating expense (add $50,000)
reserve for contingencies (less $50,000)
current liabilities (add $50,000)

Item 3
In2010 plant maintenance expenditures
were $44,000.
Normally, plant maintenance expense
was about $60,000 a year and $60,000
had indeed been budgeted for 2010.
Management decided, however, to
economize in 2010, 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.

Answer
The plant maintenance expense should
be recorded at its actual expenditure of
$44,000.
Thus, $16,000 should be deducted from
plant maintenance expense, increasing
net income and Retained earnings, and
noncurrent liability.
operating expense (less $16,000)
noncurrent liability (less $16,000)
retained earnings (add $16,000)

Item 4

In early January 2010 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 noncurrent liability.
When questioned about this treatment,
the financial VP 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?

Item 5
The

$20,000 bond discount was reduced

by $784 in 2010, and Ms. Warshaw
calculated that this was the correct
amount of amortization.

However, the $784 was included as item

of non-operating expense on the income
statement, rather than being charged
directly to Retained earnings.

Answer

The$784 bond discount amortization was

correctly recorded as a non-operating
expense item.

Item 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 VP, issuing bonds is an unusual
financial transaction for us, not a routine
operating transaction.

Answer

Legal fees are Issuance Cost.

The correct approach is to record this in the
Balance sheet as a deferred charge.
However, $500 is a small item to matter and is
immaterial.
Thus, we considered the immediate
expensing of the item though recorded as an
operating expense.

operating expense (add 500)

non operating expense (less 500)

Item 7
On

January 2, 2010, 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 yearend lease payments, title to the car would
pass to Norman, which expected to use
the car through at least year-end 2014.

The $13,581 lease payment for 2010 was

included in operating expenses in the
income statement.

Although Mr. Burrows recognized that

some of 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.

Answer
The $20,000 discount should have been
recorded as a discount deducted from
the face amount of the bond in liabilities.
It matters where the discount appears
because it affects the total assets and
total liabilities amounts as well as
debt/equity ratios.
other deferred charges (less 20,000)
noncurrent liabilities (less 20,000)

Answer

Answer

The lease is considered a capital lease.

The entry should be:
Equipment 35,000
Capital Lease Obligation 35,000
plant & equipment (add 35,000)
non current liability(add 35,000)

At the end of the year, depreciation on

the asset should be charged. Using
straight-line method, entry is:
Depreciation Expense 7,000
Accumulated Depreciation 7,000

operating expense (add 7,000)

accumulated depreciation (add 7,000)
retained earnings (less 7,000)

The $13,581 lease payment should

include interest and a part that reduces
liability.
To compute interest
=13,581 * 8%

Interest Expense
$2,800
Capital Lease Obligations 10,781

Cash

13,581

operating expense (less 10,781)

noncurrent liabilities (less 10,781)
retained earnings (add 10,781)