Accounting Case: LaSorda Company's management has always relied on very conservative accounting policies, resulting in the following balance sheet as of December 31, 20X8.
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LASORDA COMPANY BALANCE SHEET DECEMBER 31, 20X8
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ASSETS
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Current assets
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Cash
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$ 15,000
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Short-term investments in stock
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$ 45,000
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Less: Allowance for decline in market value
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5,000
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40,000
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Accounts receivable
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$ 75,000
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Less: Allowance for uncollectable
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7,500
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67,500
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Inventory
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125,000
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Total current assets
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$247,500
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Property, plant, & equipment
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Land
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$ 85,000
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Buildings
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$289,000
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Less: Accumulated depreciation
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78,319
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210,681
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Equipment
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$ 80,000
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Less: Accumulated depreciation
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48,000
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32,000
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Total property, plant & equipment
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327,681
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Intangibles
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Patent
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28,000
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Total assets
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$603,181
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LIABILITIES & STOCKHOLDERS" EQUITY
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Current liabilities
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Accounts payable
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$ 22,000
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Salaries payable
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7,000
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Taxes payable
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8,000
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Total current liabilities
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$ 37,000
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Long-term liabilities
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Bank loans payable
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115,000
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Total liabilities
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$152,000
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Stockholders' equity
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Common stock
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$ 50,000
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Retained earnings
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401,181
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451,181
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Total liabilities & stockholders' equity
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$603,181
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George LaSorda, president of the company has been approached by a party desiring to buy the firm at a price equal to 200% of stockholders' equity. George agreed that the price would be fair if stockholders' equity were revised to reflect the following:
- Short-term investments-The market value of the short-term investments was $85,000 on December 31, 19X8. The reported cost of $45,000 was accurate; however, the $5,000 allowance was established long ago, and investment values have since recovered. This recovery has never been recognized. George desires to report the company's holdings at the market value of $85,000.
- Accounts receivable- The Allowance account is presently equal to 10% of the outstanding receivables balance. LaSorda believes that the company should estimate uncollectible accounts at 2% of the firm's sales ($400,000). The balance in the Allowance account at the beginning of the year was $3,000, and customer write-offs during 19x8 totaled $7,000.
- Inventory- Inventory is valued by using the LIFO method. George reports that income for the last three years would have been $45,000 higher had FIFO been employed. (The company is only three years old.) LaSorda desires to use FIFO when calculating the revised stockholder's equity figure.
- Buildings-The company's three-year-old buildings are being depreciated by the double-declining balance method, based on a 20-year life and $30,000 residual value. George believes the straight-line method would be more appropriate.
- Equipment-The equipment, which is two years old and has no residual value, is being written of by the sum-of-the-years'-digits method over a five-year life. Again, George prefers the straight-line method.
- Patent- The patent was acquired for $28,000 at the beginning of the current year. George believes that this intangible should not be amortized and desires to report the patent at acquisition cost. The original service life of the intangible should have been estimated at 10 years.
Instructions -
a. Which of George's preferences violate generally accepted accounting principles? Briefly explain the reason for the violation other than consistency principle.
b. Prepare the balance sheet and compute the purchase price that would result if George's preferences were used. Use generally accepted accounting principles throughout, especially where George's alternatives are technically incorrect. (Hint: All changes in the company's income will be reflected by the changes in retained earnings.) Ignore the consistency principle violations.