What information regarding inventories and property, plant, and equipment must be disclosed by Koch Corporation in the audited financial statements issued to stockholders, either in the body or the notes, for the 2010–2011 fiscal year?
(Disclosures Required in Various Situations) Ace Inc. produces electronic components for sale to manufacturers of radios, television sets, and digital sound systems. In connection with her examination of Ace’s financial statements for the year ended December 31, 2011, Gloria Rodd, CPA, completed field work 2 weeks ago. Ms. Rodd now is evaluating the significance of the following items prior to preparing her auditor’s report. Except as noted,
none of these items have been disclosed in the financial statements or notes.
A 10-year loan agreement, which the company entered into 3 years ago, provides that dividend payments may not exceed net income earned after taxes subsequent to the date of the agreement. The balance of retained earnings at the date of the loan agreement was $420,000. From that date through December 31, 2011, net income after taxes has totaled $570,000 and cash dividends have totaled $320,000. On the basis of these data, the staff auditor assigned to this review concluded that there was no retained earnings restriction at December 31, 2011.
Due to the fact the terms of the loan agreement have been already worked out and disclosed the part of the dividend payments should be talked about separately. Since the retained earnings were not talked about within the terms of the agreement they are not required to be shown but it does mention that there needs to be a relationship shows between the net income increasing and the paid dividends. A CPA would want to talk with the client about the disclosures coming from showing the increase because the company might show a loss during one of the years. Even though there may be a loss the company could still pay dividends but only if the earnings in the previous years were not circulated.
Recently Ace interrupted its policy of paying cash dividends quarterly to its stockholders. Dividends were paid regularly through 2010, discontinued for all of 2011 to finance purchase of equipment for the company’s new plant, and resumed in the first quarter of 2012. In the annual report dividend policy is to be discussed in the president’s letter to stockholders.
Even if the policy is for the company to include the information of the company discontinuing the payments of cash dividends in 2011 in the president’s letter to stockholders they need to make sure to include the information in the notes of the financial statements. This way there are no questions as to why payments stopped and why there was a spike from the nonpayment of the dividends. Item 3
A major electronics firm has introduced a line of products will compete directly with Ace’s primary line, now being produced in the specially designed new plant. Because of manufacturing innovations, the competitor’s line will be of comparable quality but priced 50% below Ace’s line. The competitor announced its new line during the week following completion of field work. Ms. Rodd read the announcement in the newspaper and discussed the situation by telephone with Ace executives. Ace will meet the lower prices that are high enough to cover variable manufacturing and selling expenses but will permit recovery of only a portion of fixed costs.
The introduction of products that will compete directly with Ace’s primary line does not have a current effect and should not be disclosed on the financial statements. Modifications and decisions are necessary to ensure that Ace will be able to compete with the major electronics firm in the future. Changes should be considered in the manufacturing process and with the specially designed new plant. Ace must explore avenues that will allow it to cover its variable manufacturing costs, selling expenses, and the total of fixed costs.
The company’s new manufacturing plant building, which cost $2,400,000 and has an estimated life of 25 years, is leased from Wichita National Bank at an annual rental of $600,000. The company is obligated to pay property taxes, insurance, and maintenance. At the conclusion of its 10-year noncancellable lease, the company has the option of purchasing the property for $1. In Ace’s income statement, the rental payment is reported on a separate line. On the income statement, the charge for depreciation and the charge for interest for the liability of the lease should be shown. The disclosures for the option of purchasing the property for $1 at the end of the lease would include details of the option to purchase along with a description of the lease agreement, a schedule detailing the future lease payments along
with the latest balance currently, and the total am