Until 2010, Norman Corporation, a young manufacturer of specialty consumer products, had not had its financial statements audited. It had, however, relied on the auditing firm of Kline & Burrows to prepare its income tax returns. Because it was considering borrowing on a long-term note and the lender surely would require audited statements, Norman decided to have its 2010 financial statements attested by Kline & Burrows.
Kline & Burrows assigned Jennifer Warshaw to do preliminary work on the engagement, under the direction of Allen Burrows. Norman's financial vice president had prepared the preliminary financial statements shown in Exhibit 1. In examining the information on which these financial statements were based, Ms. Warshaw discovered the facts listed below. She referred these to Mr. Burrows.
Questions
1. How should each of the above seven items be reported in the 2010 income statement and balance sheet?
2. (Optional-requires knowledge of appendix material.) The bond described in item 4 above has a 15-year maturity date. What is the yield rate to the investor who paid $80,000 for this bond? Is the $784 discount amortization cited in item 5 indeed the correct first-year amount? (Assume that the $5,000 annual interest payment is made in a lump sum at year-end.)
3. (Optional) If the lease in item 7 is determined to be a capital lease, what is its effective interest rate?
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EXHIBIT 1 NORMAN CORPORATION Proposed Income Statement (condensed) For the Year 2010 Net sales Cost of sales Gross margin Operating expenses Operating income Nonoperating income and expense (net) Pretax income Provision for income taxes Net income $1,658,130 1,071,690 586,440 329,100 257,340 9,360 247,980 99,300 5 148,680 Proposed Balance Sheet (condensed) As of December 31, 2010 Assets Current assets 107,026 Cash and short-term investments Accounts receivable, gross $262,904 5,250 Less: Allowance for doubtful accounts Inventories Prepaid expenses 257,654 376,006 10,814 751,500 Total current assets Plant and equipment, at cost 310,996 139,830 Less: Accumulated depreciation Goodwill Development costs Other deferred charges Total assets 171,166 101,084 124.648 166,878 $1,315,276 Liabilities and Shareholders Equity Current liabilities Noncurrent liabilities 421,770 228,704 650,474 100,000 82,500 432,302 50,000 $1,315,276 Total liabilities Common stock (100,000 shares) Capital surplus Retained earnings Reserve for contingencies Total liabilities and shareholders' equity