Ali Reiners, a new controller of Luftsa Corp., is preparing the financial statements for the year ended December 31, 2011. Luftsa is a publicly traded entity and therefore follows IFRS. As a result of this review, Ali has found the following information.
1. Luftsa has been offering a loyalty rewards program to its customers for about five years. In the past, the company has not recorded any accrual related to the accumulated points as the amounts were not significant. However, with recent changes to the plan in 2011, the loyalty points are now accumulating much more rapidly and have become material.
Ali has decided that effective January 1, 2011, the company will defer the revenue related to these points at the time of each sale, which will result in a liability.
2. In 2011, Luftsa decided to change its accounting policy for depreciating property, plant, and equipment to depreciate based on components and also to adopt the revaluation model. The company hired specialized appraisers at January 1, 2011, to determine the fair values, useful lives, and depreciable amounts for all of the components of the assets. In prior years, the company did not have sufficient documentation to be able to apply component accounting, and the appraisers were not able to determine this information.
3. One division of Luftsa Corp., Rosentiel Co., has consistently shown an increasing net income from period to period. On closer examination of its operating statement, Ali Reiners noted that inventory obsolescence charges are much lower than in other divisions. In discussing this with the division’s controller, Ali learned that the controller knowingly makes low estimates related to the writeoff of inventory in order to manage his bottom line.
4. In 2011, the company purchased new machinery that is expected to increase production dramatically, particularly in the early years. The company has decided to depreciate this machinery on an accelerated basis, even though other machinery is depreciated on a straight-line basis.
5. All products sold by Luftsa are subject to a three-year warranty. It has been estimated that the expense ultimately to be incurred on these machines is 1% of sales. In 2011, because of a production breakthrough, it is now estimated that 0.5% of sales is sufficient. In 2009 and 2010, warranty expense was calculated as $64,000 and $70,000, respectively.
The company now believes that warranty costs should be reduced by 50%.
6. In reviewing the capital asset ledger in another division, Usher Division, Ali found a series of unusual accounting changes in which the useful lives of assets were substantially reduced when halfway through the original life estimate. For example, the useful life of one truck was changed from 10 to 6 years during its fifth year of service. The divisional manager, who is compensated in large part by bonuses, indicated on investigation, “It’s perfectly legal to change an accounting estimate. We always have better information after time has passed.”
Ali Reiners has come to you for advice about each of the situations. Prepare a memorandum to the controller, indicating the appropriate accounting treatment that should be given to each situation. For any situations where there might be ethical considerations, identify and assess the issues and suggest what should be done.