1. Capitalizing interest on the new factory:
a. During the year, Frosty Co. paid all of the interest accrued on Bond A and Loan 1, but only $50,000 of the interest accrued and due on Loan 2. Using one journal entry, summarize how Frosty originally recorded the accrued interest on all three long-term debts.
b. Assume that John and Elsa are right that the new loan meets the standards for capitalizing interest, but the amount of capitalizable interest is only $28,392. What correcting entries would need to be made to properly record interest on Frosty Co.'s construction project? (Hint: Assume that Frosty Co.'s income tax rate is 30 percent. Any necessary changes to Frosty Company's taxes triggered by your adjustment should affect Income Tax Expense and Income Tax Payable.)
c. What would be the net effect of each of these interest adjustments on net income? What would be the net effect on EPS?
2. Recording the asset retirement obligation (ARO) on the new plant:
a. Assuming that payments will be made at the end of each year, determine the amount that Frosty Co. should recognize for the ARO. (Hint: Your calculation should take into account the time value of money.)
b. Assuming Frosty Co.'s management team decides to record the ARO, what correcting entries would need to be made?
c. What would be the net effect of the ARO adjustment on the current year's net income? What would be the net effect on EPS?
3. Recording the write-down on obsolete inventory:
a. Based on the information provided in Table 2, calculate the write-down that would be necessary using the second set of assumptions.
b. Assuming that Frosty Co.'s management team decided to use the second set of estimates, what correcting entries would need to be made to write down inventory?
c. What would be the net effect of the inventory writedown on net income assuming the second set of estimatesis used? What would be the net effect on EPS?
4. Recording the change from the percentage of sales to the percentage of accounts receivable method of calculating bad debt expense:
a. Calculate the amount of bad debt expense Frosty Co. would recognize using the percentage of sales method.
b. Assuming that the management team has decided to switch from the percent of accounts receivable method to the percent of sales method for estimating bad debt expense, what correcting entries would need to be made?
c. What would be the net effect of this change in method on net income? What would be the net effect on EPS?
5. Evaluating each adjustment:
a. Based on the accounting standards, can Frosty Co. capitalize the interest on the construction project? Explain.
b. Based on the accounting standards, does Frosty Co. need to recognize the ARO in these ?nancial statements? Explain.
c. Based on the discussion in the case, which set of lower of cost or market assumptions do you think is the most appropriate? Explain.
d. Do you think that Frosty Co. should switch methods of calculating bad debt expense? Explain.
6. Updating Frosty Co.'s ?nancial statements:
a. Based on the correcting entries you made in Questions 1-4 and your answers to Question 5, make any necessary changes to Frosty Co.'s income statement (see Table 3).
b. Based on your correcting entries and your changes to the income statement, make any necessary changes to Frosty Co.'s balance sheet (see Table 4).
c. If necessary, update Frosty Co.'s statement of cash ?ows (see Table 5).
7. Analyzing the consequences of your adjustments (round your ratio values to three decimal places):
a. Calculate Frosty Co.'s EPS, Current Ratio, Pro?t Margin, ROA, and Debt to Equity Ratio using the original ?nancial statements.
b. Recalculate the ratios using your adjusted ?nancial statements from Question 6.
c. Assuming that either set of assumptions can be used to determine the amount of inventory write-down, which set of ?nancial statements do you think the management team would prefer? Which set would Frosty Co.'s investors prefer? Defend your answers in one paragraph (maximum of 100-150 words).
8. Resolving the con?ict between Frosty Co.'s upper management:
Simon (the controller) felt that three of the issues presented in the case should be resolved immediately. Doug and Jane (the CFO and CEO) felt that the ?nancial statements should be left alone. Using your knowledge of GAAP, Frosty Co.'s business goals, the principles of business ethics, and your answers to Questions 1-7, do the following:
a. Write one paragraph defending Simon's opinion.
b. Write one paragraph defending Doug and Jane's position.
c. Assuming that Jane insists on leaving the books as they are, write one paragraph on Simon's possible options.
(Note: Each paragraph should be no longer than 100-150 words.)