2. Assets Liabilities
Current liabilities
$ 444,000 Accounts payable $ 800,000
820,000 Accrued expenses payable 100,000
-41,000 Unearned Revenue 200,000
779,000 Total current liabilities $ 1,100,000
1,270,000
30,000 Noncurrent liabilities
Total current assets $ 2,523,000 Notes payable $ 1,320,000
Deferred income taxes 325,000
Noncurrent assets Total Liabilities $ 2,745,000
Property, plant & equipment, gross $ 3,940,000
Less: Accumulated depreciation -1,810,000 Owner's equity
Property, plant & equipment, net 2,130,000 Common stock, $1 par $ 2,000,000
Retained earnings 1,268,000
Land 560,000 Total owners' equity $ 3,268,000
Deferred research & development costs 800,000
Total assets $ 6,013,000 Total liabilities & owners' equity$ 6,013,000
As of December 31, 2016
XYZ Imports
Balance Sheet
Current assets
Cash
Accounts receivable
Inventories
Less: Allowance for uncollectible A/R
Net Accounts receivable
Prepaid expenses
3. Sales Revenue $ 4,750,000
Less: Cost of production
Beginning inventory $ 1,205,000
Cost of production 3,665,000
Goods available for sale 4,870,000
Less: Ending inventory 1,720,000
Add: LIFO Reserve 134,000
-3,284,000
Gross margin $ -1,466,000
Less: Research & development expense 700,000
Depreciation expense 330,000
Selling and administrative expense 400,000
Bad debt expense 41,000
-1,471,000
Net income before taxes -5,000
Less: Income Tax 0
Net income after taxes $ -5,000
XYZ Imports
For the Year Ended December 31, 2016
Income Statement
4. $1,809,000
-5,000
-316,000
Less: Adjustments for Accumulated Depreciation -220,000
$1,268,000
Add: Net Income for fiscal year 2016
Ending Balance Retained Earnings Dec. 31, 2016
Beginning Balance,
Retained Earnings Jan. 1, 2016
Less: Adjustments for Beginning Balance, Inventory, Jan. 1, 2016
XYZ Imports
Statement of Retained Earnings
For the Year Ending 12/31/2016
5. Part B. Supporting Documentation for the Restatement
1. Bad debt expense 41,000
Allowance for Uncollectible Accounts Receivable 41,000
Explanation: See the second correcting entry, we will know the ending accounts receivable
is $820,000, so the allowance for uncollectible accounts receivable is $820,000*5% =
$41,000
2. Revenue 200,000
Cash 200,000
Cash 200,000
Unearned Revenue 200,000
Explanation: Assuming the payment is made when merchandise is ordered, the original entry
that records revenue and cash needs to be reversed. Besides, I debit cash back and credit
unearned revenue for the merchandise that is not shipped.
3. Depreciation Expense 230,000
Accumulated Depreciation 230,000
Retained Earnings 220,000
Accumulated Depreciation 220,000
Explanation: To comply with conservative GAAP, accelerated depreciation method is
adopted. Thus, I debit depreciation expense and credit accumulated depreciation with
$230,000 with the $230,000 in depreciation expense. In the mean time, the accumulated
depreciation account would be greater by $450,000 in total as of 12/31/16. The difference
between $450,000 and $230,000 is $220,000, which will reduce the retained earnings.
4. Cost of Goods Sold 134,000
LIFO Reserve 134,000
Explanation: To comply with conservative GAAP, I choose to use LIFO for inventory
valuation. The difference of inventory value between FIFO and LIFO is recorded as
allowance for LIFO reserve. By adjusting beginning balance of inventory from $1,205,000 to
6. $889,000, COGS decreases by $316,000. By adjusting ending balance of inventory from
$1,720,000 to $1,270,000, COGS increases by $450,000. The difference between these two
adjustments increases the COGS in 2016 by $134,000. Thus, debit COGS and credit
allowance for LIFO reserve.
5. Research & Development Expenses 350,000
Deferred Research & Development Costs 350,000
Explanation: Because no viable asset had been developed, it is not appropriate to capitalize
R&D expenditures. I make a correcting entry to adjust the R&D expense to its actual amount
by subtracting the misstated amount of deferred R&D costs and adding back another half of
the actual expenditures to R&D expense. That’s why I debit R&D expense and credit
deferred R&D costs.
6. Deferred Tax Liability 475,000
Income Tax Expense 475,000
Explanation: According to my calculation, there is no income taxes expense occurred during
the fiscal year of 2016. Thus, it reduces income taxes expense with the deferred tax liability.
7. Part C. Analysis of Creditworthiness of XYZ Imports
To compare the creditworthiness of XYZ Imports as revealed by the original versus the
restated financial statement, three metrics of creditworthiness are viewed as most appropriate
in my analysis.
First of all, liquidity ratio, the company’s ability to pay off the short-term debt obligations,
is the utmost because this ability largely influences the confidence of our commercial bank in
XYZ Imports with its payments. Here I mainly focus on the balance sheet and calculate the
current ratio by dividing current assets with current liabilities. In the original statement, the
current ratio is 3.35:1, which represents that XYZ Imports have enough current assets, which
are three times as many as current liabilities, to cover short-term debts in an emergency.
However, with the revaluation of current assets and liabilities, the current ratio is lower to
2.23:1. The change also indicates that XYZ Imports have less current assets to pay off the
short-term debt obligations. This change make a difference to the creditworthiness of XYZ.
Second, profit and profitability is taken into consideration. I address this metric mainly
with the income statement. Return on equity and the ratio of net income to sales are
illustrated for this metric. Return on equity is essential for a local company that manufactures
electronic components for computers. Now that XYZ Imports maintains a small research and
development staff, they may develop some advanced technology, which may become their
patent, and maintain it as their competitive advantage. In the original income statement, ROA
is $535,000/7,304,000=12.5%; while in my restatements, ROA is negative because they show
a negative loss under conservative GAAP, which does not signal a healthy growth of XYZ
Imports. Besides, net income to sale in the original statement is $535,000/4,950,000=10.8%,
while the one in my restatement is also a negative number. That a company with negative
ROA and net income to sales signals a warning to a company’s creditworthiness.
8. Last but not the least, debt-to-equity ratio is calculated as my third metric of
creditworthiness. Debt ratio is used to measure a company’s financial leverage. In the
original financial statements, the debt-to-equity ratio is $3,020,000/4,284,000 = 70.5%, which
indicates a high level of debt that XYZ Imports is using to finance its assets relative to the
amount of value represented in shareholders’ equity. In my restatement, the debt-to-equity of
XYZ Imports is $2,745,000/3,628,000 = 75.66%. The five percent increase implies that XYZ
Imports needs to reply more upon debts to facilitate its operation. The unhealthy structure of
XYZ Imports’ financing activities arouses my concerns on its creditworthiness to pay its debt
on time.
9. Part D. Opinions on Ethics of XYZ Imports
Based on the analysis of creditworthiness, I think that the managers of XYZ Imports have
made some unethical financial reporting choices.
The most noticeable unethical reporting is the net income after tax in the original income
statement. I went through the original calculation of net income and found out that net
income after tax should be $475,000 instead of $535,000. In my opinion, the managers of
XYZ Imports intentionally increased net income after tax by $60,000 greater because it is
impossible to get $535,000 out of miscalculation. In this way, ROE, ROA and Net Income to
sales cannot be metrics of creditworthiness in my analysis. Managers have the responsibility
to present a fair and clean financial reporting, otherwise they are on the opposite side of
shareholders. From this aspect, I can say that it is not ethical for XYZ Imports to manipulate
any numbers on the financial statement.
What’s more, I don’t think that it is appropriate to capitalize half of the R&D expenditures.
XYZ’s policy with respect to capitalized R&D costs was to begin amortization only after a
commercially viable asset had been developed. To date, however, no viable asset had resulted
from the research program represented by the currently capitalized R&D expenditures.
Therefore, no R&D expenditures should be capitalized. As managers, they should have clear
awareness of what they should account for and when they should capitalize R&D
expenditures. Nevertheless, they capitalize half of these expenditures. I strongly doubt with
the intent of this misconduct of accounting. By reducing the R&D expenditures, they increase
the net income and the assets, pretending that they earn $350,000 more. As a result, assets,
net income and retained earnings are overstated. It is another example of unethically
manipulating and misreporting the financial statements.
In all, I believe that the managers of XYZ Imports have made come unethical financial
reporting choices.
