Correction of an error - entry and reporting B-15.

01

Roll Call manufactures a unique keychain with a built-in radio frequency identification chip. This device is
issued to students at State University, and a host computer tracks student attendance at each class by auto-
matically monitoring the whereabouts of the keychains.

Roll Calls ending inventory at December 31, 20X3 was $1,670,000. However, this value was transposed and
entered into the accounting system at $1,760,000. As a result, ending inventory was overstated and cost
of goods sold was understated by $90,000. This error was discovered in March of 20X4, when the CFO was
preparing a presentation for potential investors.

The 20X3 books have long-since been closed, and financial reports were already released. The CFO proposed
to correct the error by debiting Cost of Goods Sold and crediting Inventory for $90,000. Net income for 20X3
was $900,000, and 20X4 should be at about the same level.

(a) What is the appropriate journal entry to correct the error? You may assume the firm uses a periodic
inventory system, and the balance of the Inventory account is shown as $1,760,000.

(b) In the CFO presentation to potential investors, how much should be reported as 20X3 net income?
How much should be reported as inventory on hand at December 31, 20X3?

(c) Is the amount of the error material? If you are an accountant for Roll Call and instructed by the CFO
to record the erroneous entry, what should you do?
B-15.02 Disposal of a business unit

Work safety regulations require that the side walls of ditches and trenches be supported by various devices
to protect workers from collapse. Trench Coat manufactures and sells a spray on concrete product that sup-
ports the walls of recently excavated trenches.

Several years back, the company formed a separate business unit that provides spray on surface linings for
swimming pools. That business unit has failed to meet managements goals. At the beginning of 20X8, Trench
Coat sold the swimming pool business, resulting in a $250,000 pretax gain.

The trench coating product continues to be very successful. During 20X8, product sales were $7,000,000, at
a gross margin of 35%. Selling expenses totaled $800,000 and administrative expenses totaled $1,200,000.
Trench Coat is subject to a 40% income tax rate.

(a) Prepare the 20X8 income statement assuming that management views the disposal of the
swimming pool business as a strategic shift.

(b) Prepare the 20X8 income statement assuming that the disposal of the swimming pool business is
not a strategic shift.
 Reporting comprehensive income B-15.03

Melanie Mielke Construction Corporation is considering the appropriate accounting for two unrelated events
during the year. The first event related to the effects of a labor strike that resulted in a work stoppage on
a major construction project. $2,000,000 of building material that was left exposed to weather conditions
during the strike was lost. The second event was a $3,000,000 unrealized gain on available-for-sale securities
that continue to be held as an investment.

Melanie Mielke's annual sales were $9,000,000, at a gross margin of 15%. Selling expenses totaled $300,000,
and administrative expenses totaled $800,000. Mielke is subject to a 30% income tax rate.

Prepare the 20XX income statement for Melanie Mielke Construction Corporation.
B-15.04 Reporting changes in accounting methods

At the beginning of 20X2, Devin Company changed its method of accounting for certain operating ex-
penses. The change in methods shifted from one acceptable method to another acceptable method. Devin
Company's accounting department was not sure how to report the effect of the change, and has prepared
the following alternative comparative income statements.

The first option includes a cumulative effect catch-up adjustment for the change.

The second option results in changing the amount of operating expenses previously reported for 20X1. The
company faces a 35% tax rate.

Which of the two income statements should be used? What was the dollar impact of the change in method,
before and after tax. Did the change impact any years prior to 20X1?

DEVIN COMPANY
Income Statement
For the Years Ending December 31, 20X1 and 20X2
20X2 20X1
Sales $6,500,000 $5,000,000
Cost of goods sold 3,000,000 2,700,000
Gross profit $3,500,000 $2,300,000
Operating expenses 2,100,000 1,650,000
Income from continuing operations before income tax $1,400,000 $650,000
Income tax on income from continuing operations 490,000 227,500
Income from continuing operations $910,000 $422,500
Cumulative effect of change in method, net of tax 190,000 -
Net income $1,100,000 $422,500

DEVIN COMPANY
Income Statement
For the Years Ending December 31, 20X1 and 20X2
20X2 20X1
Sales $6,500,000 $5,000,000
Cost of goods sold 3,000,000 2,700,000
Gross profit $3,500,000 $2,300,000
Operating expenses 2,100,000 1,357,692
Income from continuing operations before income taxes $1,400,000 $942,308
Income tax on income from continuing operations 490,000 329,808
Net income $910,000 $612,500
 Concepts including OCI/ROA/EBIT/EBITDA/etc. B-15.05

Three of the following statements are patently false. Find the three false statements. The other statements
are true, and may include additional insights beyond those mentioned in the textbook.

Earnings is synonymous with income from continuing operations plus or minus the effects
of any discontinued operations.

Changes in accounting estimates must be reported by retrospective adjustment.

EBIT and EBITDA are accounting values that are required to be reported on the face of the
income statement.

Other comprehensive income can be reported on the face of a statement of comprehensive

income or in a separate reconciliation.

When there is reported change in value for available for sale securities, comprehensive in-
come becomes synonymous with net income.

Book value per share is an amount related to shares of common stock.

B-15.06 Earnings per share

Trinity Railway began 20X5 with 900,000 shares of common stock outstanding. On March 1, 20X5, Trin-
ity Railway issued 300,000 additional shares of common stock. 50,000 shares of common stock were reac-
quired on October 1. Trinity Railway reported net income of $2,275,000 for the year ending December 31,
20X5. Trinity Railway paid $250,000 in common dividends during 20X5.

(a) Calculate the weighted-average common shares outstanding for 20X5.

(b) Calculate basic earnings per share for 20X5.

(c) If Trinity Railway also had preferred stock outstanding, and declared and paid $227,500 in
dividends on these shares during 20X5, calculate the revised amount for basic earnings per share.

(d) Explain the concept of diluted EPS. What types of additional securities would Trinity Railway likely
need to issue before it would be become necessary to calculate a diluted EPS amount?
 P/E, PEG, Dividend rates B-15.07

Calculate the price earnings ratio, PEG ratio, dividend rate, and dividend payout ratio for each of the
following companies. Will each ratio consistently rank the companies from "best" to "worst" performer?
x
Earnings Dividends Market Price Average Annual
Per Share Per Share Per Share Increase in Earnings SPREADSHEET
TOOL:
Andrews Corporation $2.50 $0.00 $25.00 5%
Data sort
Borger Corporation $1.00 $1.00 $18.00 10%
Calvert Corporation $5.00 $2.50 $20.00 5%
Dorchester Corporation $1.25 $0.00 $10.00 25%
Easton Corporation $2.50 $0.75 $50.00 30%
Flores Corporation $2.00 $0.10 $25.00 20%
Gerber Corporation $0.10 $0.00 $5.00 10%
Houston Corporation $0.50 $0.25 $20.00 3%
B-15.08 Book value per share

Brazil Corporation has a simple capital structure, and its equity section follows:

Stockholders Equity
Common stock, $0.50 par value, 800,000 shares authorized, $150,000
300,000 shares issued and outstanding

Paid-in capital in excess of par - common stock 750,000

Retained earnings 2,400,000
Total stockholders equity $3,300,000

Chile Corporation has a complex capital structure, and its equity section follows:

Stockholders Equity
Capital stock:
Preferred stock, $50 par value, callable at 103, 5%, $3,000,000
cumulative, 100,000 shares authorized,
60,000 shares issued and outstanding

Common stock, $1 par value, 500,000 shares authorized,

200,000 shares issued and outstanding 200,000 $3,200,000
Additional paid-in capital
Paid-in capital in excess of par - preferred stock $60,000
Paid-in capital in excess of par - common stock 800,000 860,000
Total paid-in capital $4,060,000
Retained earnings 6,910,000
Total stockholders equity $10,970,000

With the exception of the current year's preferred dividend which is now due, Chile has paid all dividends
on the preferred stock.

Determine the issue price of each company's common and preferred stock. Determine the book value per
common share for each company.
 Return on assets and return on equity B-15.09

Calculate the return on assets and return on equity for the following companies. What appears to be the
average interest rate faced by the companies? As a broad generalization, which companies appear to be
effectively utilizing debt to improve financial performance?

Interest Preferred Average Average

Net Income Expense* Dividends Assets Equity

Alejando Corp. $120,000 $10,000 $0 $1,100,000 $1,000,000

Ling Corp. $100,000 $80,000 $20,000 $1,900,000 $1,100,000
Beaufort Corp. $700,000 $200,000 $15,000 $4,000,000 $2,000,000
Robinson Corp. $300,000 $200,000 $100,000 $6,000,000 $4,000,000

* Note: Many analysts use the "after tax" cost of interest (i.e., $1 of interest only costs $0.75 if a
company faces a 25% tax rate) in calculating the return on assets. The idea is to determine how
much higher income would be without the interest impact. For purposes of this problem you may
simply use the interest expense shown.
B-15.10 Qualitative characteristics of accounting

Match the following accounting qualities to the appropriate explanations that follow:

Relevancy
Faithful representation
Comparability
Consistency
Verifiability
Timeliness
Understandability

(a) Deviations in measured outcomes from period to period should be the result of deviations in
underlying performance (not accounting quirks).

(b) Clear and concise to those with reasonable business knowledge.

(c) Available in sufficient time to be capable of influence.

(d) Even though different companies may use different accounting methods, there is still sufficient
basis for valid comparison.

(e) Information must be truthful; complete, neutral, and free from error.

(f ) Information should be timely and bear on the decision-making process by possessing predictive
or confirmatory (feedback) value.

(g) Different knowledgeable and independent observers reach similar conclusions.

 Identification of professional organizations B-15.11

Provide the correct name of the organization that is being referenced by the following descriptions.

This organization is viewed as centric to the coordination of global harmonization of account-

ing standards.

This organization passed "Section 404" requiring public companies to implement a robust sys-
tem of internal control.

This organization is the primary private-sector accounting rule-making body in the U.S.

This organization is no longer in existence, but once issued opinions on acceptable account-
ing practices.

This organization is a professional association of accountants who are seeking to advance the
practice of accounting.

This organization was created many years ago, and it is charged with administration of laws that
regulate the reporting practices of companies whose stock is publicly traded.

This organization is charged with overseeing the auditors of public companies.

B-15.12 Accounting assumptions

Match the following accounting assumptions to the appropriate explanations that follow:

Entity assumption

Going-concern assumption

Periodicity assumption

Monetary unit assumption

Stable currency assumption

(a) Overcomes mixing alternative measurements into the financial statements.

(b) A continuous business process can be segmented into discrete intervals.

(c) Provides for an orderly allocation of costs and revenues over extended time periods.

(d) Justification for consolidating the accounts of separate legal entities.

(e) Because of this, changing currency values due to inflation effects are disregarded.
 Concepts in international accounting B-15.13

Match the following terms and concepts to the appropriate explanations that follow:

International Accounting Standards Board

Translation

Remeasurement

Convergence

Reporting currency

Local currency

(a) The currency of the country in which a subsidiary operates.

(b) The anticipated direction of global GAAP development.

(c) The world-wide equivalent of the FASB.

(d) The currency of the country in which financial statements are prepared for owners.

(e) Conversion process that uses a variety of exchange rates for assets.

(f ) The "plug" adjustment is an item of "other comprehensive income."

B-15.14 Foreign currency transactions - purchasing activity

Universal Instruments is based in the U.S. and prepares its financial statements in dollars. The company uses
a perpetual inventory system. On December 5, 20X5, Universal had two separate purchase transactions from
suppliers in Europe.

The first transaction was for $100,000. Terms of sale provide for settlement in dollars.
The account was paid in full on January 11, 20X6.

The second transaction was for 100,000. Terms of sale provide for settlement in euros.
The account was paid in full on January 11, 20X6.

The exchange rate of dollars for euros fluctuated as follows:

December 5, 20X5: $1.47 per euro

December 31, 20X5: $1.46 per euro
January 11, 20X6: $1.49 per euro

Prepare journal entries showing the inventory purchase, year-end adjustment (if necessary), and final settle-
ment for each of these two transactions.
 Foreign currency transactions - sales activity B-15.15

Global Technology is based in the U.S. and prepares its financial statements in dollars. On December 5, 20X5,
Global had two sales transactions with customers in Europe.

The first transaction was for $100,000. Terms of sale provide for settlement in dollars.
Payment in full was received on January 11, 20X6.

The second transaction was for 100,000. Terms of sale provide for settlement in euros.
Payment in full was received on January 11, 20X6.

The exchange rate of dollars for euros fluctuated as follows:

December 5, 20X5: $1.47 per euro

December 31, 20X5: $1.46 per euro
January 11, 20X6: $1.49 per euro

Prepare journal entries showing the sale (you may ignore cost of sales), year-end adjustment (if necessary),
and final settlement for each of these two transactions.
I-15.01 Income reporting for complex fact situation

Stearns Corporation was a diversified company with two separate lines of business - chemicals and financial
services. At the beginning of 20X7, a strategic shift resulted in Stearns selling its financial services unit, result-
ing in a $3,000,000 pretax gain. The following additional transactions and events pertain to 20X7:

The chemical unit sold a paint factory at pretax loss of $500,000. This asset sale did not represent
a strategic shift for Stearns.

General information for 20X7 is as follows: Sales, $7,500,000; Cost of Goods Sold, $3,200,000;
Selling Expenses, $1,000,000; and General & Administrative Expenses, $1,500,000. The company's
income tax rate is 30%.

Stearns changed its method of accounting for inventory at the beginning of 20X7. The cost of
goods sold of $3,200,000 is based on the new method. Cumulatively, prior years' income would
have been $2,400,000 higher (net of tax effects) had the new method been in use all along.

The company discovered an error in a prior year's report. The error resulted in a $420,000 over-
statement of 20X5 net income.

(a) Prepare the 20X7 income statement for Stearns Corporation.

(b) Retained earnings at January 1, 20X7, was $5,500,000 before giving consideration to the
correction of error or accounting change described above. What is the balance of the revised begin-
ning retained earnings?

(c) If the company had $400,000 of other comprehensive income (net of any tax effects) related to
holding gains on available for sale securities, how much is total "comprehensive income?"
 Earnings per share - basic and diluted I-15.02

Case Corporation has common and preferred stock outstanding at December 31, as follows:

3,400,000 shares of $1 par value common stock. The company started the year with 3,000,000
shares, issued 600,000 shares on July 1, and reacquired 200,000 shares on October 1.

100,000 shares of $100 par value, 5% preferred. These shares have been outstanding all year,
and the $500,000 dividend was declared and paid during the year.

The company's net income for the full year was $2,600,000.

(a) Compute the company's basic earnings per share.

(b) Additionally, assume the preferred stock is convertible into 1,000,000 shares of common stock.
Compute the company's diluted earnings per share. For this calculation, the numerator will be
net income, as you will assume that the preferred dividend was not paid ("if" the preferred was
converted to common, the preferred dividend would not have been paid). The denominator will
be the weighted-average common shares plus the number of shares that would be issued on
conversion (i.e., 1,000,000).
I-15.03 Ratios and valuations

Roscovis Corporation's December 31, 20X6, equity section follows:

Stockholders Equity
Capital stock:
Preferred stock, $100 par value, callable at 105, 4%, $5,000,000
cumulative, 200,000 shares authorized,
50,000 shares issued and outstanding

Common stock, $2 par value, 1,000,000 shares authorized,

400,000 shares issued and outstanding 800,000 $5,800,000
Additional paid-in capital
Paid-in capital in excess of par - preferred stock $50,000
Paid-in capital in excess of par - common stock 4,000,000 4,050,000
Total paid-in capital $9,850,000
Retained earnings 7,400,000
Total stockholders equity $17,250,000

Roscovis Corporation has annually paid all preferred dividends. There were no changes in paid-in capital
during all of 20X6. The beginning retained earnings was $5,400,000. The ending balance of retained
earnings is the result of $3,000,000 in net income and $1,000,000 in total dividends.

Determine the maximum price you would pay for a share of common stock in Roscovis if you have the
following investment constraints:

Maximum Price/Earnings Ratio 15 X

Maximum Multiple of Book Value 3X

Minimum Dividend Yield 3%

 Team-based approach to foreign currency transactions I-15.04

This problem requires you to team with one other person. One of you will assume the role of accountant
for Company A (based in Miami), and the other for Company B (based in London). You should each prepare
your company's journal entries for the following purchase and sale transactions. On the sale transactions,
you may disregard recording of any cost of goods sold. Compare your results and consider why Company
A's foreign currency transaction gain or loss is not offset on Company B's books (and vice versa).

Sale of inventory by Company A to Company B:

This transaction was for $5,000, on account. The date of sale was March 1, and settlement
occurred on April 1.

Sale of inventory by Company A to Company B:

This transaction was for 2,500, on account. The date of sale was April 1, and settlement
occurred on May 1.

Purchase of inventory by Company A from Company B:

This transaction was for $7,000, on account. The date of purchase was May 1, and
settlement occurred on June 1.

Purchase of inventory by Company A from Company B:

This transaction was for 3,500, on account. The date of purchase was June 1, and
settlement occurred on July 1.

The exchange rate of dollars ($) for pounds () fluctuated as follows:

March 1: $2.00 per pound

April 1: $2.10 per pound
May 1: $2.05 per pound
June 1: $1.95 per pound
July 1: $2.00 per pound