GRAPHIC APPAREL CORPORATION

DISCUSSION QUESTIONS FOR STUDENT GUIDANCE

1. What are the key changes affecting GAC this year?
1. Who owns GAC?

Ans: Nicki owns GAC since January 2014.

2. Who uses GAC's financial statements?

Ans:The bank and other lenders uses GACs financial statements.

3. What is significant about GAC's business relationship with its new user?

Ans:GACs business relationship with its new customers is very important for the
company to grow and increase or maintain its sales because the company has already lost
its many sales to former and reliable customers.

2. What are the big events to account for in 2014?

1. How is the custom shirt business working out?

Ans:The custom out shirt business is working out pretty well.Nicki worked tirelessly to
secure more custom orders from local teams and community organizations. At the end of
August 2014, GAC secured $10,000 of sales order. So, considering this GAC seems to be
doing well in sales of custom shirts.

2. What do we know about GAC's customer base?

Ans:GACs customers are start-up clothing stores,retailers, local sports teams and
community organizations.

3. How is the new graphic design working out?

Ans:The new bold and inspiring graphic shirts were able to attract new customers
but the old customers didn't like the idea, so they cut back the order for the 2014
season.However, sought new customers and applied aggressive marketing strategy which
helped her to get new customers to replace old ones.

4. What happened at the warehouse this year?

Ans: There was leakage at the warehouses roof.

3. What is the revenue principle? At what point does GAAP indicate revenue should be recognized?
Provide the FASB ACS citation(s).
 Ans: The revenue principle states that revenue should be recognized when the earnings process is
virtually complete and collection is reasonably assured.

According to GAAP, revenue should be recognized when buyer of companys product agrees to
purchase and the amount customer is going to pay is determined.

FASB ASC 650 Revenue Recognition

4. When does GAC report its revenue from custom orders? Under what circumstances would this
be appropriate?

GAC reports its revenue from custom orders when a signed order and payment is received from a
customer.

Under revenue recognition based on IFRS this circumstance is appropriate.

4. What alternative point in time exists for reporting revenue from custom orders?

Ans;As an alternative, GAC can report revenue from custom orders at the point of delivery.

5. What method do you think is best for recognizing revenue from custom shirts? What arguments
support that method?

Ans:Percentage-of -completed contract method is best for recognizing revenue from custom
shirts. The reasons are:

a) Net Income will be higher in first years but lower in the last years.

b)Net Income will be less volatile.

c)Total assets will be greater.

d)Liabilities will be lower.

6. How would changing to this alternative method affect GAC's financial statements? How would
changing to this alternative method affect GAC's current ratio?

Ans: If you change method to completed contract method , then the following changes will
occur in GACs financial statement:

a)Net income will be nonexistent in the first years and higher in the last year.

b)Net income will be very volatile.

c)Total assets will be smaller.

 d)Liabilities will be higher (no recognition of retained earnings).

e)Stockholders equity will be lower.

f)Stockholders equity will be more volatile.

Changing to this alternative method will lower the current ratio.

7. At what value does GAAP require accounts receivable to be reported? Provide the FASB ACS
citation(s).

Ans:GAAP requires accounts receivable to be reported at fair-value option.

FASB ASC 310 10 25

8. What method of accounting for bad debts does GAC use? When is this method okay?

Ans: GAC uses Allowance method in accounting for bad debts.

This method is okay when specific customers order is identified as uncollectible and when we
really can predict what percent of sales cannot be uncollected.

Direct write-off method. It is okay when the uncollectable account is immaterial.

9. Has anything changed this year to suggest this approach is no longer acceptable? What do you
learn from the number of days to collect receivables in 2014 versus 2013?

This year Nikki made changes to the companys customers so she expects $3000 uncollectable
debt, which is material compare to $15000 sales. In 2013, customers were more able to pay
within the collection period.

10. What alternative method could GAC use for bad debts? Does any evidence suggest it is better?

Allowance Method,the 2014 gross margin is smaller than 2013 gross margin even 2014 sales are
bigger than 2013s, thats because the company were using direct write-off method and it directly
reduce sales with cost of good sold stays the same.

11. What method of accounting for bad debts do you think GAC should use?

Allowance, since the bank requires financial statements in accordance with GAAP.
12. How would changing to this alternative method affect GAC's financial statements? How would
changing to this alternative method affect GAC's current ratio?

A/R will be bigger, net income will be bigger. Current ratio will be bigger.

13. When does GAC report sales returns? Under what circumstances is that method acceptable?
Provide the appropriate FASB ASC citation(s).

In the month that goods are returned. This method is acceptable if the return amount is not
anticipated to be material.

FASB ASC 605-15-45-1(Revenue recognition- products- other presentation matters- general)

14. Have circumstances surrounding returns changed in 2014? How?

yes, in 2013, retailer didnt have trouble selling most of the t-shirts so there werent material
amount of returns but this year in 2014, a lot of t-shirts are not sold at the end.

15. What does GAAP recommend under these new circumstances?

to reduce sales revenue and account receivable by the amount of returns in the period of sale.

16. Should GAC consider this alternative? Why? Are sales returns material to the key external user?

yes. recognizing returns and allowances only as they occur could cause profit to be overstated in
the period of the sale and understated in the return period.

17. Which method of accounting for sales returns do you think is best?

record in the sales period

18. How would changing to this alternative method affect GAC's financial statements? How would
changing to this alternative method affect GAC's current ratio?

net income for 2014 will be smaller, current ratio will be smaller.

19. Using what measurement does GAAP require inventory to be reported? Provide the appropriate
FASB ASC citation(s).

GAAP requires Inventory to be reported at lower of cost or market. FASB ASC 330-10.

20. Using what measurement has GAC been reporting its inventory? When is this appropriate?

GACs policy has been reporting its inventory at lower of cost or market. GAC also is currently
using the weighted average cost method. Currently, inventories are being recorded at cost. This is
 most appropriate when a company wishes to assume that items sold and items in ending
inventory come from a mixture of all goods available for sale.

21. Has anything changed this year to suggest this approach is no longer acceptable? What do you
learn from the number of days to sell inventory in 2014 versus 2013?

GAC still acquires inventory in the same way which they always have, stock piling a large
quantity of inventory during the winter. They then sell it over the course of the year. Since this
has not changed this inventory measurement is still appropriate.

It may be required though, due to damage to some shirts to take into account the fact that some
shirts may have to be discounted. Revenues for those shirts would then have to be matched.

Because her customers cut back on orders during 2014 versus 2013, the number of days to sell
inventory likely lengthened. Her efforts to replace these orders with new customers probably
helped to reduce the impact of those cutbacks though.

22. Is there any evidence to suggest that GAC will have to mark down its selling price below cost?
What does the gross profit percentage in 2014 indicate about the margin of difference between
selling price and cost?

The damage to GACs inventory of shirts provides some evidence that the selling price may have
to be marked down below cost on those shirts. The gross profit percentage in 2014 declined
roughly 4% which could be indicative of lower selling prices and the return of unsatisfactory
merchandise.

23. What do you think GAC should do when reporting its inventory of graphic shirts?

It would be beneficial for GAC to report their inventory using at lower of cost or market. This
would help identify any issues with inventory that is damaged. Damaged inventory in this case
would then be reported at market value.

24. How would changing to the alternative method affect GAC's financial statements? How would
changing to this alternative method affect GAC's current ratio?

Since, inventory is currently being reported at cost, changing to a market value for shirts
damaged and then printed on will reduce the value of GACs inventory by roughly 50%. This
change would reduce GACs current ratio.

25. If all the proposed changes were made, how would GAC's current ratio change?

GACs current ratio would fall below 1.0.

26. How much additional equity would Nicki need to contribute to return GAC to a current ratio of
1.0?
 Additional equity equal to the amount of the inventory decrease would have to be invested into
the business. The effect would be an increase in current assets which would increase GACs
current ratio to the acceptable minimum level.

27. What next steps would you recommend for Nicki?

Finance continuing operations using debt. Continue relationships with loyal customers and find
a balance between the edgy new designs and more conservative designs they were happy with.
Continue to grow relationships with new customers and tailor orders specifically for them, this
will allow your business to grow. As your business grows so will theirs if they continue to order
your shirts. A restating of 2014s financial statements would benefit GAC as well in order to
more accurately reflect damaged inventory items.