Norman Corporation

8/10/2019 Norman Corporation

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Presented By:-Utkarsh Aggarwal(151)

Aatish Mathur(152)ChandraPrakash(153)

Samridhi Chopra(154)Shaily(155)

Saurav Jaiswal(156)


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Flow Of Presentation

Background

Objectives

Case analysis

Debt ratios

Summary


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Background Norman Corporation is a young manufacturer

of specialty consumer product.

Until 2010, it had not had its financialstatements audited. It relied on the auditingfirm of Kline & Burrows to prepare its incometax returns.

Norman decided to have its financialstatements attested by Kline & Burrows

because it was considering borrowing on along-term note and the lender surely wouldrequire audited statements.


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Kline and Burrows assigned JenniferWarshaw to do the preliminary work onthe engagement under the direction ofAllen Burrows.

Normans financial VP had prepared thepreliminary financial statements.

In examining the information on which

these financial statements were based,Ms Warshaw discovered several items.She referred these to Mr. Burrows.


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Item 1

In 2010 a group of female employeessued the company, asserting that there

salaries were unjustifiably lower thansalaries of men doing comparable work.They asked for backpay of $250,000.

A large number of similar suits have been

filed in other companies, but results wereextremely varied.


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Normans outside counsel thought that thecompany probably would win the suit but

pointed out that the decisions thus farwere divided, and it was difficult toforecast the outcome.

In any event it was unlikely that the suit

would come to trial in 2011. No provisionfor this loss has been made in the financialstatements.


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Answer

In order to recognize an expense relatedto this contingency, it must be feasible tomake an estimate of at least the minimumamount of loss. In this case no suchestimate is available, so no amountshould be recorded.

However, the existence of the suit shouldbe disclosed in a note to the financialstatements.


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Item 2

There is a second lawsuit outstanding.

It involved a customer who was injuredby one of the companys products and

asked for $ 500,000 damages.

Based on discussions with customersattorney, Normans attorney believed thatthe suit probably could be settled for $50,000. There was no guarantee of this ofcourse.


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On the other hand if the suit went to trial,Norman might win it.

Norman did not carry product liabilityinsurance.

Norman reported $50,000 as a Reserve

for Contingencies with a correspondingdebit to Retained Earnings.


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AnswerA loss contingency should be recognized.

However, it should be recorded asexpense or loss on the income statement(not immediately debited to Retained

Earnings) And a liability on the balance sheet (not

a Reserve for Contingencies)

operating expense (add $50,000)

reserve for contingencies (less $50,000)

current liabilities (add $50,000)


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Item 3

In2010 plant maintenance expenditureswere $44,000.

Normally, plant maintenance expensewas about $60,000 a year and $60,000

had indeed been budgeted for 2010. Management decided, however, to

economize in 2010, even though it wasrecognized that the amount would

probably have to be made up in futureyears.


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In view of this, the estimated incomestatement included an item of $60,000 for

plant maintenance expense, with anoffsetting credit of $16,000 to a reserveaccount included as a noncurrent liability.


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Answer

The plant maintenance expense shouldbe recorded at its actual expenditure of$44,000.

Thus, $16,000 should be deducted fromplant maintenance expense, increasingnet income and Retained earnings, andnoncurrent liability.

operating expense (less $16,000) noncurrent liability (less $16,000)

retained earnings (add $16,000)


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Item 4 In early January 2010 the company issued a 5

percent $100,000 bond to one of itsstockholders in return for $80,000 cash.

The discount of $20,000 arose because the 5

percent interest rate was below the goinginterest rate at the time;

the stockholder thought that thisarrangement provided a personal income tax

advantage as compared with an $80,000bond at the market rate of interest.


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The company included the $20,000discount as one of the components of theasset other deferred charges on thebalance sheet and included the $100,000as noncurrent liability.

When questioned about this treatment,the financial VP said, I know that othercompanies may record such atransaction differently, but after all we do

owe $100,000. And anyway what does itmatter where the discount appears?


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Item 5

The $20,000 bond discount was reducedby $784 in 2010, and Ms. Warshawcalculated that this was the correct

amount of amortization.

However, the $784 was included as itemof non-operating expense on the income

statement, rather than being chargeddirectly to Retained earnings.


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Answer

The$784 bond discount amortization wascorrectly recorded as a non-operating

expense item.


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Item 6 In connection with the issuance of the

$100,000 bond, the company hadincurred legal fees amounting to $500.

These costs were included in non-operating expenses in the incomestatement because, according to the

financial VP, issuing bonds is an unusualfinancial transaction for us, not a routineoperating transaction.


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Answer

Legal fees are Issuance Cost.

The correct approach is to record this in theBalance sheet as a deferred charge.

However, $500 is a small item to matter and isimmaterial.

Thus, we considered the immediateexpensing of the item though recorded as anoperating expense.

operating expense (add 500)

non operating expense (less 500)


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Item 7

On January 2, 2010, the company hadleased a new Lincoln Town Car, valued at$35,000, to be used for various official

company purposes.

After three years of $13,581 annual year-end lease payments, title to the car would

pass to Norman, which expected to usethe car through at least year-end 2014.


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The $13,581 lease payment for 2010 wasincluded in operating expenses in theincome statement.

Although Mr. Burrows recognized thatsome of these transactions might affectthe provision for income taxes, hedecided not to consider the possible taximplications until after he had thoughtthrough the appropriate financialaccounting treatment.


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Answer

The $20,000 discount should have beenrecorded as a discount deducted fromthe face amount of the bond in liabilities.

It matters where the discount appearsbecause it affects the total assets andtotal liabilities amounts as well asdebt/equity ratios.

other deferred charges (less 20,000) noncurrent liabilities (less 20,000)


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Answer


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Answer

The lease is considered a capital lease.

The entry should be:

Equipment 35,000

Capital Lease Obligation 35,000

plant & equipment (add 35,000)

non current liability(add 35,000)


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At the end of the year, depreciation onthe asset should be charged. Usingstraight-line method, entry is:

Depreciation Expense 7,000

Accumulated Depreciation 7,000

operating expense (add 7,000)

accumulated depreciation (add 7,000) retained earnings (less 7,000)


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The $13,581 lease payment shouldinclude interest and a part that reducesliability.

To compute interest =13,581 * 8%

Interest Expense $2,800

Capital Lease Obligations 10,781

Cash 13,581

operating expense (less 10,781)

noncurrent liabilities (less 10,781)

retained earnings (add 10,781)

Norman Corporation

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