At
December 31, 2011, Bouvier Corp. has assets of $10 million, liabilities of $6
million, common shares of $2 million (representing 2 million common shares of
$1.00 par), and retained earnings of $2 million. Net sales for the year 2011
were $18 million, and net income was $800,000. As one of the auditors of this
company, you are making a review of subsequent events on February 13, 2012, and
you find the following.
1.
On February 3, 2012, one of Bouvier’s customers declared bankruptcy. At
December 31, 2011, this company owed Bouvier $300,000, of which $40,000 was
paid in January 2012.
2.
On January 18, 2012, one of the client’s three major plants burned.
3.
On January 23, 2012, a strike was called at one of Bouvier’s largest plants and
it halted 30% of production. As of today (February 13), the strike has not been
settled.
4.
A major electronics enterprise has introduced a line of products that would
compete directly with Bouvier’s primary line, now being produced in a specially
designed new plant. Because of manufacturing innovations, the competitor has
been able to achieve quality similar to that of Bouvier’s products, but at a
price 30% lower. Bouvier officials say they will meet the lower prices, which
are barely high enough to cover variable and fixed manufacturing and selling
costs.
5.
Merchandise traded in the open market is recorded in the company’s records at
$1.40 per unit on December 31, 2011. This price held for two weeks after the
release of an official market report that predicted vastly excessive supplies;
however, no purchases were made at $1.40. The price throughout the preceding
year had been about $2.00, which was the level experienced over several years.
On January 18, 2012, the price returned to $2.00 after public disclosure of an
error in the official calculations of the prior December—the correction erased
the expectations of excessive supplies. Inventory at December 31, 2011, was on
a lower of cost or net realizable value basis.
6.
On February 1, 2012, the board of directors adopted a resolution to accept the
offer of an investment banker to guarantee the marketing of $1.2 million of
preferred shares.
7.
The company owns investments classified as trading securities accounted for
using the fair value through net income model. The investments have been
adjusted to fair value as of December 31, 2011. On January 21, 2012, the annual
report of one of the investment companies has been issued for its year ended
November 30, 2011. The investee company did not meet its earnings forecasts and
the market price of the investment has dropped from $49 per share at December
31, 2011, to $27 per share on January 21, 2012.
Instructions
For
each event, state how it will affect the 2011 financial statements, if at all.
The company follows IFRS.
1. The financial statements should be adjusted
for the expected loss pertaining to the remaining receivable of $260,000. Such
adjustment should reduce accounts receivable to its realizable value as of
December 31, 2011.
2. Report
the fire loss in a note to the balance sheet and refer to it in connection with
the income statement, since earnings power is presumably affected.
3. Strikes
are considered general knowledge and therefore disclosure is not required. Many
auditors, however, would encourage disclosure in all cases.
4. This
case is a difficult problem. If this event is of the second type that provides
evidence with respect to conditions that did not exist at December 31, 2011,
then appropriate disclosures should indicate that:
(a) Recovery
of costs invested in plant and inventory is in doubt.
(b) The
company may incur additional costs to modify the existing facility.
(c) Due
to this situation, future economic events cannot be determined.
If it is the first type of subsequent
event and the condition existed at December 31, 2011, then the financial
statements must be adjusted. The provisions of accounting for contingencies
would govern if amounts could not be estimated. It should be emphasized in
class that no right answer exists for this problem. Judgement must play a major
role in determining the adjustment or disclosure necessary for this
transaction. Consideration should be given whether the going concern assumption
is appropriate under the circumstances.
5. Adjust
the inventory figure as of December 31, 2011 as required by a market price of
$2.00 instead of $1.40, applying the lower of cost and net realizable value
principle. The actual quotation was a transitory error and no purchases had
been made at this quotation.
6. Report
the action of the new share issue in a note to the financial statements, as
this has relevance to the users, particularly existing shareholders.
7. This
is a subsequent event that provides evidence about conditions that did not
exist at the balance sheet date. The
decline in value, if material in effect on Bouvier’s statements, would be
disclosed in the notes to the financial statements. The loss would not be
recorded in the December 31, 2011 financial statements.
