Accounting and Auditing
PART 1- ACCOUNTING
Current Liabilities and Contingencies
The chapter focuses on current liabilities and contingencies and includes topics covering the nature, definition, and valuation of current liabilities. An explanation of the items that make up current liabilities is included. Specific methods of reporting current liabilities on the balance sheet and in the notes to the financial statements are also covered.
Current Liabilities and Contingencies, discusses characteristics of and accounting for current liabilities and contingencies.
There are three essential characteristics of a liability for a company:
a. A liability involves an obligation that will be settled by a probable future transfer or use of assets at a specified or determinable date, on occurrence of a specified event, or on demand.
b. The obligated company has little or no discretion to avoid the future sacrifice.
c. The transaction or other event obligating the company has already happened.
Current liabilities are obligations of a company that it expects to liquidate by using existing current assets or creating other current liabilities within one year or an operating cycle, whichever is longer. An operating cycle is the time normally required to convert cash into inventory, sell the inventory, and collect the resulting receivables.
Compensated absences include vacation, holiday, illness, or other personal activities for which a company pays its employees. They do not include severance pay, stock options, or long-term fringe benefits.
Payroll taxes are paid by both the company (employer) and employee. Taxes withheld from employees’ pay include federal and state (and sometimes local) income taxes payable by the employee, and the employee’s social security (Federal Insurance Contribution Act, or F.I.C.A.) taxes.
Property taxes are assessed by local (and some state) governments on the value of property as of a given date. They become a legal liability on the date, specified by law, when a lien arises against the property.
Product warranties require the seller, for a specified period of time after the sale, to correct any defect in the quality, quantity, or performance of merchandise, or replace items, or refund the selling price.
The FASB used three terms describing the likelihood that a loss contingency will be confirmed: (a) probable – the future event is likely to occur, (b) reasonably possible – the chance of the future event occurring is more than remote but less than likely, (c) remote – the chance of the future event occurring is slight.
A company accrues an estimated loss from a loss contingency and reports a loss (or expense) and a liability (or a reduced asset) in its financial statements if (a) it is probable that a liability has been incurred (or an asset impaired) at the date of the financial statements, and (b) the company can reasonably estimate the amount of the loss.
Following the convention of conservatism, and the revenue recognition criteria, gain contingencies usually are not accrued. Instead, they are disclosed in the notes to the financial statements.
***ANSWER THE FOLLOWING****
C13-9 VARIOUS CONTINGENCY ISSUES
Skinner Company has the following contingencies:
1. Potential costs due to the discovery of a possible defect related to one of its products. These costs are probable and can be reasonably estimated.
2. A potential claim for damages to be received from a lawsuit filed this year against another company. It is probable that proceeds from the claim will be received by Skinner next year.
3. Potential costs due to a promotional campaign whereby a cash refund is sent to customers when coupons are redeemed. Skinner estimated, based on past experience, that 70% of the coupons would be redeemed. In actuality, 40% of the coupons were actually redeemed and the cash refunds sent this year. The remaining 30% of the coupons are expected to be redeemed next year.
1. How should Skinner report the potential costs due to the discovery of a possible product defect? Explain the reasons for your answer.
2. How should Skinner report this year the potential claim for damages that may be received next year? Explain the reasons for your answer.
3. This year, how should Skinner account for the potential costs and obligations due to the promotion campaign? Explain the reasons for your answer.
PART 2 and 3- AUDITING
Audit of Cash and Other Liquid Assets; Audit of Fixed Assets and Related Expense Accounts
Organizations also seek to manage cash and liquid assets to maximize their overall potential return. This can challenge the auditor when the market value of new and more complex securities is not readily available. The unit explains six major steps used in an audit to minimize this high-risk control area.
This unit demonstrates analytical procedures that are generally effective in estimating expense accounts associated with long-lived assets. Areas of focus include changes made during the year and the final preparation made before issuing an audit opinion. Are the financial statements fairly presented in all material respects? Internal quality-review programs help ensures that no major audit procedures have been left out and that the documentation supports the audit opinion.
Cash, the most liquid of assets, needs extensive controls to secure it. On the other hand, fixed assets are more difficult to convert to cash but have other issues. Accounting estimates are used to estimate the useful lives of fixed assets. Estimates are sometimes wrong and need to be corrected. We also have the issue of distinguishing between an asset and an expense.
Asset impairment refers to management’s recognition that a significant portion of fixed assets is no longer as productive as had originally been expected. Impaired assets should be written down to their expected economic value. Goodwill (the excess of the purchase price for an economic entity over the sum of the fair market value of specifically identifiable tangible and intangible assets) only arises when one organization purchases another and identifies the combined entity’s superior earning power.
***ANSWER THE FOLLOWING****
Two separate paragraphs
1. What are the major authorization principles the auditor should investigate regarding both cash management and investments in marketable securities?
2. What are the major elements of an internal control over property, plant, and equipment? For the specific control procedures identified, indicate their importance to the audit.
***ANSWER THE FOLLOWING****
Visit the FASB web site, http://www.fasb.org/st/index.shtml. See how many pronouncements you can find on leases.
1. Summarize the FASB pronouncements on leases