Norman Corporation (A)*
Until 2006, Norman Corporation, a young manufacturing of specialty products, had not had its financial statements audited. It had, however, relied on the auditing firm of Kline & Burrows to prepare its income tax returns. Because it was considering borrowing on a long-term note and the lender surely would require audited statements, Norman decided to have its 2006 financial statements attested by Kline & Burrows.
Kline & Burrows assigned Jennifer Warshaw to do preliminary work on the engagement, under the direction of Allen Burrows, Norman’s financial vice president had prepared the preliminary financial statements shown in Exhibit 1. In examining the ...view middle of the document...
Norman reported $50,000 as a Reserve for Contingencies, with a corresponding debit to Retained Earnings.
3. In 2006 plant maintenance expenditures were $44,000. Normally, plant maintenance expense was about $60,000 a year and $60,000 had indeed been budgeted for 2006. Management decided, however, to economize in 2006, even thought it was recognized that the amount would probably have to be made up in future years. In view of this, the estimated income statement included an item of $60,000 for plant maintenance expense, with an offsetting credit of $16,000 to a reserve account included as a concurrent liability.
4. In early January 2006 the company issued a 5 percent $100,000 bond to one of its stockholders in return for $80,000 cash. The discount of $20,000 arose because the 5 percent interest rate was below the going interest rate at the time; the stockholder thought that this arrangement provided a personal income tax advantage as compared with $80,000 bond at the market rate of interest. The company included the $20,000 discount as one components of the asset “other deferred charges” on the balance sheet and included the $100,000 as a concurrent liability. When questioned about this treatment, the financial vice-president said, “I know that other companies may record such a transaction differently, but after all we do owe $100,000. And anyway, what does it matter where the discount appears?”
5. The $20,000 bond discount was reduced by $74 in 2006, and Ms. Warshaw calculated that this was the correct amount of amortization. However, the $784 was included as an item of non-operating expense on the income statement, rather than being charged directly to Retained Earnings.
6. In connection with the insurance of the $100,000 bond, the company had incurred legal fees amounting to $500. These costs were included in non-operating expenses in the income statement because according to the financial vice-president, “issuing bonds is an unusual financial transaction for us, not a routine operating transaction.
7. On January 2, 2006, the company had leased a new Lincoln Town Car, valued at $35,000, to be used for various official company purposes. After three years of $13,581 annual year-end lease payments, title to the car would pass to Norman, which expected to use the car through at least year-end 2010. The $13,581 lease payment for 2006 was included in operating expenses in the income statement.
Although Mt Burrows recognized that some of these transaction might affect the provision for income taxes, he decided not to consider the possible tax implications until after he had thought through the appropriate financial accounting treatment.
1. How should each of the above seven items be reported in the 2006 income statement and balance sheet?
2. (Optional-requires knowledge of appendix material.) The bond described in item 4 above has a 15-year maturity date. What is the yield rate to the investor...