Capreol Carpet Corporation (CCC) is a manufacturer of broadloom carpeting, located in Winnipeg, Manitoba. The company enjoys a good reputation for its product, but unfortunately has not been very profitable in recent years owing to increasing imports of cheaper carpeting. In order to combat this threat, CCC has invested substantial sums of money in new equipment to improve efficiency. Although efficiency picked up as a result, the improvement seemed only to keep the profit picture from getting any worse, rather than to actually increase net income.

CCC is a public company, but control was held by Bay and Eastern Corporation, a large conglomerate. Three months ago, Bay and Eastern sold its 70% interest in CCC to Upper Lip Enterprises Ltd., a British carpet manufacturer.

Upper Lip planned to integrate CCC into its own operations, such that CCC would be the manufacturer of certain carpets sold by all of Upper Lip’s distributors and would be the North American distributor of Upper Lip’s Britishmade carpets.

Last week, the financial vice-president of Upper Lip sent a letter to David Blase, the controller of CCC, in which he detailed certain changes in accounting policy that CCC should institute in order to make its reporting practices consistent with those of Upper Lip, for purposes of consolidation and divisional performance appraisal. Included in the letter were the following:

1. Inventories, both of raw materials and finished goods, should be valued on the LIFO basis rather than on the average-cost basis previously used by CCC.

2. Carpeting sold to Upper Lip and its other subsidiaries should be billed at standard cost plus 10%, rather than at full list price less 15%, as is now the case. In effect, the gross margin on the intercompany transfers would be reduced from 35% of cost to 10% of cost. Carpet purchased by CCC from the Upper Lip group of companies would also be invoiced to CCC at cost plus 10%.

3. Depreciation on the new equipment should be increased from 8% per year (straight-line) to 12.5% per year. Standard costs would be adjusted to reflect the higher rate.

The financial vice-president, in his letter to David, has asked for a report specifically identifying and describing any problems in implementing the suggested changes in accounting policies, and giving solutions to any problems that exist.

Required:

Assume that you are David Blase. Draft the report for the vice-president on the suggested changes to the accounting policies.