Chapter 17 - Solution Manual

2 item 2 nonaccounting matters such as management

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be subject to any substantial income tax liability with respect to this matter. 2. Item 2. Nonaccounting matters such as management changes and pending proxy fights are not disclosed unless such information is needed for the proper interpretation of the financial statements. The president should be informed that footnotes are an integral part of the financial statements and as such should be limited to information that relates to the financial statements. Furthermore, there is no certainty that a proxy fight will materialize and, hence, in view of the uncertainty no reason for footnote disclosure. Disclosure of events that have no relevance to those matters essential to proper interpretation of the financial statements frequently creates doubt as to the reasons for disclosure and inferences drawn could be misleading. Information about the pending proxy fight might be included in the president's letter to the stockholders which is usually included in a company's annual report. Case 17-5 a. If a corporation's activity could be expected to be the same in all quarters, there would be no problems in using quarterly statements to predict annual results, providing one recognized that the normal activities of any corporation could be disrupted by unforeseen events such as strikes, fires, floods, actions of governmental authorities, and unusual changes in demand for goods or supply of raw materials. Most businesses, however, can be expected to have variations in activity among quarters. Any user of the financial statements who is not a member of management would probably have great difficulty in making accurate predictions. A basic cause of fluctuating quarterly activity is seasonality. Sales often show a seasonal pattern. Expenses also may show a seasonal pattern, but the pattern for any expense may differ from the patterns for sales or for the other expenses. Production, expressed in physical units, may show still another pattern. The more product lines a business has, the greater the number of varying seasonal patterns that may be present. b. Repairs and Maintenance of Factory Machinery is an example of an item which may show substantial variations which are not proportionate to either sales or production. In fact, it would not be unusual for many repair and maintenance projects to be performed during the time when production is lowest, thus causing high unit costs (high costs divided by few units) for the quarter. The effect on income would be spread between the Unknown Deleted: Unknown Deleted: .
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364 quarter of incurrence and later quarters depending on inventory levels and costing methods. Use of predetermined overhead rates would have the same effect (if variances were allocated between inventories and cost of goods sold) or else would confine the effect of the high costs to the current quarter (if variances were included in cost of goods sold). Low costs in periods of high production would result in low unit costs, the effects of which would be spread among quarters as described above.
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