Question

At December 31, 2018, Hayda Corp. has assets of $10,000,000, liabilities of $6,000,000, common stock of $2,000,000 (representing 2,000,000 shares of $1 par common stock), and retained earnings of $2,000,000. Net sales for the year 2018 were $18,000,000, and net income was $800,000. As auditors of this company, you are making a review of subsequent events on February 13, 2019, and you find the following.

1. On February 3, 2019, one of Hayda’s customers declared bankruptcy. At December 31, 2018, this company owed Hayda $350,000, of which $80,000 was paid in January 2019.

2. On January 18, 2019, one of the client’s three major plants was destroyed in a fire.

3. On January 23, 2019, a strike was called at one of Hayda’s largest plants, which halted 30% of its production. As of today (February 13), the strike has not been settled.

4. A major electronics enterprise has introduced a line of products that would compete directly with Hayda’s primary line, now being produced in a specially designed new plant. Because of manufacturing innovations, the competitor has been able to achieve quality similar to that of Hayda’s products but at a price 50% lower. Hayda officials say they will meet the lower prices, which are high enough to cover variable manufacturing and selling costs but which permit recovery of only a portion of fixed costs.

5. Merchandise traded in the open market is recorded in the company’s records at $1.40 per unit on December 31, 2017. This price had prevailed for 2 weeks, after release of an official market report that predicted vastly enlarged supplies; however, no purchases were made at $1.40. The price throughout the preceding year had been about $2, which was the level experienced over several years. On January 18, 2019, the price returned to $2, after public disclosure of an error in the official calculations of the prior December, correction of which destroyed the expectations of excessive supplies. Inventory at December 31, 2018, was on a lower-of-cost-or-market basis.

6. On February 1, 2019, the board of directors adopted a resolution accepting the offer of an investment banker to guarantee the marketing of $1,200,000 of preferred stock.

State in each case how the 2018 financial statements would be affected, if at all.

specifically which financial statements & how?

thank you.

Answer 1

Solution:

Answer: The financial statements should be adjusted for the expected loss pertaining to the remaining receivable of $270,000. Such adjustment should reduce accounts receivable to their realizable value as of December 31, 2014. 1. Report the fire loss in a footnote to the balance sheet and refer to it in connection with the income statement, since earnings power is presumably affected. 2. 3. Strikes are considered general knowledge and therefore disclosure is not required. Many auditors, however, would encourage disclosure in all cases

4 This case is a difficult problem. If this event is of the second type which provides evidence with respect to conditions that did not exist at December 31, 2014, then appropriate disclosures should indicate that: (a) Recovery of costs invested in plant and inventory is in doubt. (b) The company may incur additional costs to modify the existing facility. (c) Due to this situation, future economic events cannot be determined. (If we could determine them, pro-forma information might be appropriate.) If it is the type of subsequent event for which the condition existed at December 31, 2014, then the financial statements must be adjusted. The provisions of GAAP accounting related to contingencies would govern if amounts could not be estimated. It should be emphasized in class that no right answer exists for this problem. Judgment must play a major role in determining the adjustment or disclosure necessary for this transaction.

5. Adjust the inventory figure as of December 31, 2014, as required by a market price of $2.00 instead of $1.40, applying the lower-of-cost-or-market principle. The actual quotation was a transitory error and no purchases had been made at this quotation 6. Report the action of the new stock issue in a footnote to the balance sheet.