In
an examination of Kelsey Corporation Ltd. as of December 31, 2011, you have
learned that the following situations exist. No entries have been made in the
accounting records for these items. Kelsey follows IFRS.
1.
The corporation erected its present factory building in 1996. Depreciation was
calculated by the straight-line method, using an estimated life of 35 years.
Early in 2011, the board of directors conducted a careful survey and estimated
that the factory building had a remaining useful life of 25 years as of January
1, 2011.
2.
An additional assessment of 2011 income taxes was levied and paid in 2012.
3.
When calculating the accrual for officers’ salaries at December 31, 2011, it
was discovered that the accrual for officers’ salaries for December 31, 2010,
had been overstated.
4.
On December 15, 2011, Kelsey Corporation Ltd. declared a stock dividend of
1,000 common shares per 100,000 of its common shares outstanding, distributable
February 1, 2012, to the common shareholders of record on December 31, 2011.
5.
Kelsey Corporation Ltd., which is on a calendar-year basis, changed its
inventory method as of January 1, 2011. The inventory for December 31, 2010,
was costed by the average method, and the inventory for December 31, 2011, was costed
by the FIFO method. Kelsey is changing its inventory method as it presented
more reliable and more relevant information.
6.
Kelsey has guaranteed the payment of interest on the 20-year first mortgage
bonds of Bonbee Inc., an affiliate. Outstanding bonds of Bonbee Inc. amount to
$150,000 with interest payable at 10% per annum, due June 1 and December 1 of
each year. The bonds were issued by Bonbee Inc., on December 1, 2007, and all
interest payments have been met by the company with the exception of the
payment due December 1, 2011. Kelsey states that it will pay the defaulted
interest to the bondholders on January 15, 2012.
7.
During the year 2011, Kelsey Corporation Ltd. was named as a defendant in a
suit for damages by Anand Shahid Corporation for breach of contract. The case
was decided in favour of Anand Shahid Corporation, which was awarded $80,000
damages. At the time of the audit, the case was under appeal to a higher court.
Instructions
Describe
fully how each of the items should be reported in the financial statements of
Kelsey Corporation Ltd. for the year 2011.
1. This is a change in estimate and should be
applied to the calculations for 2011 on a prospective basis. If the impact of
the change on depreciation expense is material, note disclosure explaining the
change in estimate and the effect on earnings is required.
2. Since
income taxes are self-assessed by companies, additional assessments of prior
years’ amounts occasionally happen. This is considered a revision of an
estimate and the additional amount of income tax is expensed in 2011. If the
additional income taxes stem from an error in the preparation of the tax
return, such as unreported revenues or over-estimation of deductions, the
assessment would be treated as an accounting error. If the amounts are
determined and adjusted prior to the release of 2011 financial statements, no
particular disclosure is required. If not, such an accounting error is recorded
as an adjustment to opening retained earnings. Comparative financial statement amounts
are restated and note disclosure explaining the nature of the error and the
statement items adjusted would be included.
3. The
overstatement of 2010 officers’ salaries is an accounting error. Any impact on
2011 expenses would be corrected in the current year and the opening balance of
retained earnings would be adjusted net of any related income tax effect.
Comparative financial statement amounts and earning per share amounts are
restated and note disclosure explaining the nature of the error and the
statement items adjusted would be included.
4. The
stock dividend reduces retained earnings on the date of declaration. It would
therefore be shown on the 2011 statement of retained earnings. Since the stock
dividend is not issued before year-end, there would also be a Stock Dividend
Distributable balance included in the Share Capital section of Shareholders’
Equity. Earnings per share would be adjusted as if the shares had been
outstanding throughout the year 2011.
5. This
is a voluntary change in accounting policy as a result of switching to a policy
that provides more reliable and more relevant information. Kelsey will need to
record an adjustment to opening retained earnings for the change in policy, net
of any related income tax effect and restate the comparative statements. Note
disclosure is required explaining the change in policy and the reason for the
change. The method of applying the change (full or partial retrospective) must
be disclosed as well as the impact of the change on individual statement items.
6. The
guarantee should be (and should have been) disclosed in the notes to the
financial statements as a significant commitment. Since Bonbee Inc. has
defaulted on an interest payment, Kelsey must also determine how to account for
the contingent liability. For the interest component already due, this should
be shown as a current liability and an expense or loss charged to income (or a
receivable set up if it is considered that an asset exists in terms of collectability
from Bonbee). If Kelsey considers the possibility of having to honour the
principal amount of the bonds of Bonbee likely and measurable, then a loss and
liability will be accrued in the 2011 financial statements.
In
this case, Bonbee indicates that the defaulted interest will be paid on January
15, 2012. This is a subsequent event that provides evidence of a condition that
existed at year end. The January date will likely occur before Kelsey’s
financial statements are issued and will provide additional information to help
Kelsey determine how to account for the contingency. If the interest is not
paid on January 15, 2012, it becomes more likely that Kelsey will have to
honour the guarantee. Kelsey may have to include a note that the possibility of
loss is not determinable, or accrue the loss and liability in its year end
financial statements. If the interest is paid, Kelsey may be satisfied that the
likelihood of loss is not likely. In either case, Kelsey will have to examine
the underlying cause of Bonbee’s missed interest payment to determine the
likelihood of the guarantee being enforced against Kelsey.
7. This
is a contingent liability. The accounting treatment depends on Kelsey’s legal
counsel’s evaluation of the likelihood of loss on appeal. If the company
estimates that it is unlikely or undeterminable that they will lose the appeal
then no accrual is required. This position would be doubtful however since the
company has already been found in breach of contract. The company will have to
accrue the loss and liability. Additional note disclosure is required
describing the contingent liability and whether any unaccrued additional
exposure to loss exists.
