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ACC127 - [I F'K71—6Wle39e Case 1 Alex met with his...

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Unformatted text preview: [I F'K71—6Wle39e _ Case 1. Alex met with his accountant to discuss the financial statements his business was submitting to the bank for a much needed loan- The accountant expressed concern over the total amount of current liabilities. Alex did not understand why his accoun« tent was concerned because the total assets were $9,864,000 and the total liabilities were only $1,745,000, resulting in total equity of $8,119,000. The problem, the accoun- tant believed, was in the classifications of the assets and liabilities. Even thOugh the total assets were nearly $10 million, only $312,000 was current compared to $1,630,000 of current liabilities. The accountant said that the bankers would be worried because current assets available were less than the amount needed to cover the liabilities due within the next fiscal year. Alex still did not understand the problem; after all, his business had more total assets than total liabilities. His accountant showed him a current ratio of .19 to 1.00 ($312,000f$ 1,630,000), which meant that for eveiy dollar of current liabilities there was only 19 cents of current assets. Alex then said he could simply sell oil some equipment if necessary to pay any current liabilities that came due. His accountant explained that banks want to see how well businesses can meet current obligations without resorting to selling long-term assets. Given the situation, Alex told the accountant to simply reclassify the current liabilities to nonsur- rent and eliminate the problem. His accountant objected, stating that it would be unethical and misleading to reclassify the current liabilities. Alex could only see that all liabilities were obligations regardless of flieir due dates, and his total assets were plainly sufficient to cover liabilities- What ethical concerns did the accountant have? Would it be acceptable to reclassify some of the current liabilities? Does Alex have a valid point that the business has sufficient assets available to cover all the liabilities? Could some of the noncurrent assets be reclassified as current to demonstrate liquidity? Do you have any suggestions? Case 2. The Transmission Shop was the largest company in the state specializ- ing in rebuilding automobile transmissions. Every transmission rebuilt by the business was covered by a six-month warranty. The owner, Ron Wood, was meet- ing with his accountant to go over the yearly financial statements. In reviewing the balance sheet, Ron became puzzled by the large amount of current liabilities being reported, so he asked his accountant to explain them. The accountant said that most of the current liabilities were the result of accruals, such as the esti- mated warranty payable, some additional wages payable, and interest accrued on the note owed to the bank. The employees were not actually paid until the first week of the new year, so some of their wages had to be recorded and properly matched against revenues in the current period. Also, several months of interest expense had to be accrued on a bank loan, but the largest amount of the accrued liabilities was due to the estimated warranty expense. Ron asked whether the wages payable and the interest payable could be removed because they would be paid off shortly after the year ended. The accountant stated that accrued liabili- ties had to be properly recognized in the current accounting period, and thus they could not be removed. Ron agreed but then asked about the large accrued liability based upon the estimated warranty amounts. Again, the accountant stated that in previous years actual warranty cost had been about 5% of the total sales and therefore in the current year the estimate was accrued at 5%. Ron then informed the accountant that a new conditioning lubricant had been added to each trans- mission rebuilt, which dramatically reduced the amount of rebuilt transmissions Current Liabilities and Payroll 621 ...
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