Quiz 6: Abracadabra
Product Warranty An assurance given by the seller to the customer against the product's defects is called product warranty. It is recognized at the time of sale. a.Calculate the product warranty accrual as a percentage of sales of manufactured products for Corporation N for years ended 2002 and 2003. Hence, the product warranty accrual as a percentage of sales of manufactured products for Corporation N is 2.85% in 2002 and 2.46% in 2003. Comments: The warranty accrual amount of Corporation N is actually decreased in 2003 while sales are increased in 2003 as it is in 2002. As a result, the product warranty accrual as a percentage of sales of manufactured products for the corporation is decreased from 2.85% (in 2002)to 2.46% (in 2003). This indicates a signal of understating expenses and current liabilities decrease in current liabilities as a percentage of sales. It also states a signal that if the makeup of current liabilities is given in a note, one should check whether the accruals for the individual itemized current liabilities decrease as a percentage of sales compared to previous periods. b.1. For Company L, Signal #3 is presented as understating expenses via capitalization of expenses. But, in Corporation N's 10-K notes, it is presented as Restructuring and other Non-Recurring Charges (write-off of deferred preproduction costs). This signal indicates that one should alert for aggressive capitalization of costs when a company writes off costs are formerly capitalized.2. It is subjective that any company can capitalize its preproduction expenses and understate its reported expenses. The preproduction expenses can be incurred before it will be reimbursed or before revenue will be earned. The actual reimbursement of the expense may never occur, or the future revenue may never be earned. Hence, the future will always uncertain due to the greater time distance between an expense incurred and the future receipt of the revenue. There is likelihood that future payment will not be received and the capitalized cost will have to be written off. The write-off of previously capitalized preproduction costs shows that the company is engaged in capitalizing costs in expectation of the receipt of future reimbursement or revenue. Therefore, this should act as an alert to the reader that the company may be aggressive in minimizing its reported expenses. c.1. Pharmacy R and Corporation N both recognized vendor rebates in their income statements. In the case of Pharmacy R, the vendor rebate is applied only on those purchases related to inventory that had not yet sold. In case of Corporation N, the vendor rebate is related to the payments that the company received or anticipated to receive in future periods from the vendor. In both the cases, the recognized rebates are applied to future periods. 2. Pharmacy R manipulates (reduces)its cost of goods sold and accounts payable through improper recognition of vendor rebates. It applied the rebate on sales that had not yet occurred.Corporation N manipulates (increases)its receivables and income through improper recognition of vendor rebates. It applied on the payments purchase orders to receive in future periods from the vendor. 3. Prepare journal entry for the rebates for Pharmacy R. Accounting equation : The following is the accounting equation for the entry: Journal entry : Record the following journal entry in the books of Pharmacy R: Explanation: • Accounts payable is a liability account and it decreases by $xxx. Therefore, debit accounts payable account by $xxx. • Cost of goods sold decreases the value of equity by $xxx. Therefore, credit cost of goods sold account by $xxx. Prepare journal entry for the rebates for Corporation N. Accounting equation : The following is the accounting equation for the entry: Journal entry : Record the following journal entry in the books of Corporation N: Explanation: • Accounts receivable is an asset account and it increases by $xxx. Therefore, debit accounts receivable account by $xxx. • Other income increases the value of equity by $xxx. Therefore, credit other income account by $xxx.
Improper Deferral of Expenses Improper deferral of expenses refers to moving the cost from one asset to other asset, where there is a possibility to delay the amortization of expenses. Thus, improper deferral of expenses moves the expenses from present period to future period.The deferral of expense is to move from current to later period. Hence, the given statement is true. Therefore, the correct answer is .
Cost of Goods Sold Cost of goods sold is the amount that the merchandiser pays for the sales that have been made during the period. Cost of goods sold is otherwise called as cost of sales. A company can manipulate (reduce)its cost of goods sold through improper recognition of vendor rebates. The vendor rebate is applied only on those purchases related to inventory that had already sold. Hence, the given statement is "True". Therefore, the correct answer is .