Electric City (EC) is a public company that's been in business for 10 years and manufactures interior lights and fixtures. Last year, EC added 'Integrated LED lights' to their product line but their manufacturing facility cannot accommodate the production of these LED lights, so EC purchased a factory at the beginning of 2021 that already produced LED lights. To finance this expansion, the company issued preferred shares to the former owners of the factory. These preferred shares have guaranteed dividends to be paid yearly. The value of the shares was $98,000,000.

Today is December 18, 2021, and you, the CPA, have been assigned by the CFO to handle the accounting for the new 'Integrated LED lights' contracts and the new factory. The company's year-end is December 31, 2021 but the report, which you will submit to the CFO and CEO, is not due for another month.

(2021 is the first year the company started to sell 'Integrated LED lights')

1. EC is concerned that their current method of selling lights with an "ATTACHED" warranty is lowering their net income. If they sold these new lights with a warranty that could also be sold separately, then they could use the accounting method of "Revenue deferral" and thereby not have to expense the warranty expense at the time of sale of the new LED lights. The CFO has asked you to explain if switching the method of accounting for the warranty will increase earnings at time of sale or not. The estimated warranty cost of the 'Integrated LED lights' is $140. The selling price of each of these lights is $1,400. Warranty claims incurred by fiscal year-end were $200,000 using the current method of accounting for warranties. The junior financial accountant recorded these expenses by debiting the Warranty provision account, which was set up at time of sale.
2. The industry standard for lighting returns is 30 days, subject to a 15% restocking fee. EC is using these same terms for the new 'Integrated LED lights' On December 31, 2021 there were $200,000 sales of these lights that were still under the refund return period. EC only started selling these lights in September of this year and as such still does not have an estimate of the number of returns. Currently, no accounting has been done regarding the potential returns of these lights.
3. During January of 2011, EC had started preparing its Statement of Cash flows (SCF). Of particular interest to you was the cash Dividends paid was placed in the financing section for the first time. The amount was large and represented 10% of the revenue for the year. Another item that would likely need explaining is that tax expense was now included as a separate line in the operating section using the indirect approach. In past years, tax expense was already deducted from net earnings and therefore, not included as a separate line. Your review of the remaining items of the SCF is not materially different from previous years or unusual.

Required: Prepare the report to the CFO. Your report should:

1. Identify major forces that may affect Electric City's financial reporting objectives. Be sure to keep your answers case-specific.
2. Discuss and Explain to the CFO how each accounting issue should be accounted for. Be sure to also discuss financial statement implications (to the extent possible, specify the numerical effect, and any journal entries). If the company has violated any accounting principle(s), identify the principle(s) violated and explain the nature of the violation.

Answer rating: 100% (QA)

The primary forces that may affect Electric City s financial reporting objectives are 1 the need to ... View the full answer