On February 20, 20X4 you are well into the field work of the 12/31/20X3 audit and the following issues have arisen during the audit of Tremendous Leeds Company (TLC).

1. Service revenue
2. Account receivable from officers
3. Prepaid advertising
4. Alan Almond Company receivable
5. Inventory
6. “Bring Your Daughters and Sons to Work Day” litigation

Linda Wilson the president of TLC wants you to present your position on each of these issues as she would like your judgment as to “good GAAP” numbers. But, she has also pointed out that she understands that GAAP often does not provide a precise answer, and in such cases, she would rather error on the side of maintaining income rather than being “an overly pessimistic doomsayer.” The attitude of Board of Directors members is consistent with that of Linda.

Summarize the income effects (before taxes) of any entries that you propose on a schedule such as the following (make clear over and understatements of income):

                                                                                                            Income Effect

1. Unearned service revenue                                                            ____________
2. Account receivable from officers                                                             ____________
3. Prepaid advertising                                                                       ____________
4. Alan Almond Company receivable                                              ____________
5. Inventory                                                                                      ____________
6. “Bring your Daughters and Sons to Work Day” litigation         ____________

Issue 5: Inventory

Included in TLC’s inventory (valued using the LIFO method) are the following:

• $100,000 (cost) of computers which manufacturers ceased producing in the middle of 20X3.   Although the wholesale value of these computers now is only about $60,000, the retail value (if they could all be sold today, which they can’t be) is approximately $110,000. The selling costs of these specific machines are considered negligible, and a normal profit margin is approximately 25% of sales price. The retail market is “thin” and it will take some time to sell the computers. Management intends to sell all of these computers at retail and believes that the retail value of these computers is likely to decrease at an average rate of 5 percent every quarter for the next year; thus, on average a computer with a retail value of $1,000 on 12/31/X3 would have an average retail value of $950 and $900 during the first two quarters of 20X4, respectively. Management believes that the computers will be sold within the next year as follows--first quarter 40% of inventory, second quarter 35%, third quarter 20 %, and fourth quarter 5% at market values at the time of sale. These projections seem reasonable. It is currently February 15 and you note that sales are right on schedule and that retail prices have dropped a bit from year-end, as projected.
• Because of discontinuance of the above computers, many suppliers of parts for these computers have chosen to quit manufacturing the items with the result that shortages are occurring. As a result, TLC’s $50,000 inventory of parts for these machines has increased in value and would now cost $65,000 to replace (its retail value is $110,000). Historically, the normal profit margin on sales of parts is 40% of sales price. Also, management has pointed out to you that computers in inventory that don’t sell could be used for parts. But management does not anticipate the need to do this.
• Historically, TLC (and competitors) have in general separated Computers from Parts when calculating the lower of cost or market for inventory.

Does TLC need to record an inventory write-down to reflect a lower of cost or market value? If so, how much?

Answer rating: 100% (QA)

Part A 1 Unearned service revenue Entry Unearned Revenue Dr Income Cr 2 Account receivable from officers Entry Accounts Receivables Dr OfficersEmploye... View the full answer