Norman Corporation Group J
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Norman Corporation Group J
Introduction Norman Corp is a young manufacturer of
specialty consumer products Until 2006, the financial statements were never audited Company was considering to borrow a longterm note Hence it decided to have it’s 2006 financial statements audited by Kline & Burrows Some questions came up during the preparation of preliminary financial statements
Case Analysis Group of female employees sued the
company alleging injustice in payment They demanded a back pay of $250,000 Company was again sued by an employee who was injured by a product of company. He demanded $500,000 as compensation. But the company thinks that it can be settled at $50,000 and they can win this if this goes on for trial. They decided to report $50,000 as reserve for contingencies corresponding debit to retained earning.
In 2004 plant maintenance expenditure was
$44000. Normally plant maintenance was about $60,000 a yr. $60,000 had indeed been budgeted for 2006. Income statement of company contains this $60,000for plant maintenance expenses with an offsetting credit to reserve account as a noncurrent liability.
In January 2006 company issued $100000
bond in return of $80,000 to one of its stakeholder. Discount of 20000 arose because 5% interest rate was below the ongoing rate.
Analysis of fact one .. Only if the company is reasonably certain of
loosing lawsuit and the loss amount can be reasonably estimated is a liability recognized. and when a liability is recognized a provision is created. According to paragraph 8.4 of AS 4:
“Events occurring after the balance sheet date which do not affect the figures stated in the financial statements would not normally require disclosure in the financial statements although they be of such significance that they may require a disclosure in the report of the approving authority to enable users of financial
External is pretty certain that Norman might
win the trial. Also there is no surety that the trial will take place 2007, whenever the trial takes place in the worst case scenario we can make a reasonable estimate of the loss. Hence Norman should not create a provision for this contingency in financial statement of 2006. But when surety, for liability occurs then in keeping with the conservatism principle a provision for full $250,000 contingency should be created. For 2006, they have to provide a disclosure so the same effect in the financial
Analysis of fact 2 The company has no product liability
insurance. This is because they are reasonably certain of the quality of their product and if am insurance fund is not used for a long time and still premium is paid, it is a sunk cost. Question is since Norman is reasonably certain of winning the trial, why should they go in for creating a reserve. The discussion with the claimant lawyer, has brought down to the probable liability to $50,000. hence in keeping with the conservatism principle, Norman is creating
Analysis fact 3 The company has a budget of $60000 for P&M
maintenance. After economizing Expenditure is 44000 and 16000 is credited to non current liability. Two questions Why is the company economizing? Why are they creating the reserve? As we have one year B/S so we cannot find out the reason behind economizing. The reserve of $16000 is a non current liability so P & M expenditure of subsequent periods will first be recognized be from this reserve and then from the budgeted reserve from that year. As a result we perceive we are reducing the risk by creating the buffer to absorb the extra expenditure over the budgeted amount.
Analysis of fact 4 The company issued $100,000 bond (debt) in
return for $80,000 received from shareholder. The rate of interest is 5% (which is lower than the market rate) for which $20,000 discount has been given $20,000 is treated as deferred asset. The company is giving this discount because: 1.It does not have enough cash to pay market rate of interest 2.Bonds are usually issued for less than the bond’s par value at a discount. This is done to account for changes in the rate of return between the time the bond’s coupon rate is decided upon and when the bond is actually
From stockholder point of view, this is more
beneficial because he can get tax benefit on entire $100,000 instead of $80,000 This $20,000 fictitious asset has to be amortized
Analysis of fact 5 The discount of $20,000 is amortized in the
first year by $784 Bond issue is not a routine task for Norman Corp. so any costs associated with them should not be treated as operating expenses. Premium and discount represent adjustment over nominal interest rate ( of bonds ). Amortization of discount is treated as nonoperating charge.
Analysis of fact 6 Bond issue is not a routine task for Norman
Corp. so any costs associated with them should not be treated as operating expenses. The bond issuance charges are recorded as a deferred charge, which is an asset analogous to prepaid expenses If this accounting method is followed, the net profit for the period will go up, the value of asset will increase and amortization expenditure for subsequent periods will increase If this accounting method is followed, it is understating this year profit and overstating next year profit
Analysis of fact 7 The company has leased car valued $35,000 Annual year end lease payment of $13,581,
at the end of 3 years title of the car would pass to Norman, so the lease is Capital lease From the Income Tax point of view, the lessor can claim tax benefits on the lease payments of the lease asset only if it a operating lease. So the company cannot charge the lease payments as operating expenses.
Question 2 Maturity date is 15 years. Calculation of yield to maturity ( effective interest rate ): Rate(nper,pmt,pv,[fv],[type],[guess]) Nper = 15 years ( Maturity years ) Pmt = -5000 Pv = 80000 Fv = -1,00,000 ( principal ) Type = 0
Rate = 7% Calculation of amortization:
Interest expense = 80,000 ( market price of bond ) * 7 %
= 5600
Nominal interest = 5% * 1,00,000 = 5000 Amortization = 5600 – 5000 = 600
Therefore the amortization amount ( 784 ) calculated is not the
current first year amount.
Financial Lease The company takes the car on financial
lease. The effective rate of interest is calculated based on the Internal Rate of Return Cost of the Car Annual payment Rate of interest(IRR)
$35,000 $13,581 8%
Analysis of Financial Statement Debt/Equity Ratio = Total Liabilities/Shareholders equity = 650474/532302 = 1.22
A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense. In income statement, non-operating expense should not gain tax benefit. It should be deducted from retained earnings.
Thankyou.
Introduction Norman Corp is a young manufacturer of
specialty consumer products Until 2006, the financial statements were never audited Company was considering to borrow a longterm note Hence it decided to have it’s 2006 financial statements audited by Kline & Burrows Some questions came up during the preparation of preliminary financial statements
Case Analysis Group of female employees sued the
company alleging injustice in payment They demanded a back pay of $250,000 Company was again sued by an employee who was injured by a product of company. He demanded $500,000 as compensation. But the company thinks that it can be settled at $50,000 and they can win this if this goes on for trial. They decided to report $50,000 as reserve for contingencies corresponding debit to retained earning.
In 2004 plant maintenance expenditure was
$44000. Normally plant maintenance was about $60,000 a yr. $60,000 had indeed been budgeted for 2006. Income statement of company contains this $60,000for plant maintenance expenses with an offsetting credit to reserve account as a noncurrent liability.
In January 2006 company issued $100000
bond in return of $80,000 to one of its stakeholder. Discount of 20000 arose because 5% interest rate was below the ongoing rate.
Analysis of fact one .. Only if the company is reasonably certain of
loosing lawsuit and the loss amount can be reasonably estimated is a liability recognized. and when a liability is recognized a provision is created. According to paragraph 8.4 of AS 4:
“Events occurring after the balance sheet date which do not affect the figures stated in the financial statements would not normally require disclosure in the financial statements although they be of such significance that they may require a disclosure in the report of the approving authority to enable users of financial
External is pretty certain that Norman might
win the trial. Also there is no surety that the trial will take place 2007, whenever the trial takes place in the worst case scenario we can make a reasonable estimate of the loss. Hence Norman should not create a provision for this contingency in financial statement of 2006. But when surety, for liability occurs then in keeping with the conservatism principle a provision for full $250,000 contingency should be created. For 2006, they have to provide a disclosure so the same effect in the financial
Analysis of fact 2 The company has no product liability
insurance. This is because they are reasonably certain of the quality of their product and if am insurance fund is not used for a long time and still premium is paid, it is a sunk cost. Question is since Norman is reasonably certain of winning the trial, why should they go in for creating a reserve. The discussion with the claimant lawyer, has brought down to the probable liability to $50,000. hence in keeping with the conservatism principle, Norman is creating
Analysis fact 3 The company has a budget of $60000 for P&M
maintenance. After economizing Expenditure is 44000 and 16000 is credited to non current liability. Two questions Why is the company economizing? Why are they creating the reserve? As we have one year B/S so we cannot find out the reason behind economizing. The reserve of $16000 is a non current liability so P & M expenditure of subsequent periods will first be recognized be from this reserve and then from the budgeted reserve from that year. As a result we perceive we are reducing the risk by creating the buffer to absorb the extra expenditure over the budgeted amount.
Analysis of fact 4 The company issued $100,000 bond (debt) in
return for $80,000 received from shareholder. The rate of interest is 5% (which is lower than the market rate) for which $20,000 discount has been given $20,000 is treated as deferred asset. The company is giving this discount because: 1.It does not have enough cash to pay market rate of interest 2.Bonds are usually issued for less than the bond’s par value at a discount. This is done to account for changes in the rate of return between the time the bond’s coupon rate is decided upon and when the bond is actually
From stockholder point of view, this is more
beneficial because he can get tax benefit on entire $100,000 instead of $80,000 This $20,000 fictitious asset has to be amortized
Analysis of fact 5 The discount of $20,000 is amortized in the
first year by $784 Bond issue is not a routine task for Norman Corp. so any costs associated with them should not be treated as operating expenses. Premium and discount represent adjustment over nominal interest rate ( of bonds ). Amortization of discount is treated as nonoperating charge.
Analysis of fact 6 Bond issue is not a routine task for Norman
Corp. so any costs associated with them should not be treated as operating expenses. The bond issuance charges are recorded as a deferred charge, which is an asset analogous to prepaid expenses If this accounting method is followed, the net profit for the period will go up, the value of asset will increase and amortization expenditure for subsequent periods will increase If this accounting method is followed, it is understating this year profit and overstating next year profit
Analysis of fact 7 The company has leased car valued $35,000 Annual year end lease payment of $13,581,
at the end of 3 years title of the car would pass to Norman, so the lease is Capital lease From the Income Tax point of view, the lessor can claim tax benefits on the lease payments of the lease asset only if it a operating lease. So the company cannot charge the lease payments as operating expenses.
Question 2 Maturity date is 15 years. Calculation of yield to maturity ( effective interest rate ): Rate(nper,pmt,pv,[fv],[type],[guess]) Nper = 15 years ( Maturity years ) Pmt = -5000 Pv = 80000 Fv = -1,00,000 ( principal ) Type = 0
Rate = 7% Calculation of amortization:
Interest expense = 80,000 ( market price of bond ) * 7 %
= 5600
Nominal interest = 5% * 1,00,000 = 5000 Amortization = 5600 – 5000 = 600
Therefore the amortization amount ( 784 ) calculated is not the
current first year amount.
Financial Lease The company takes the car on financial
lease. The effective rate of interest is calculated based on the Internal Rate of Return Cost of the Car Annual payment Rate of interest(IRR)
$35,000 $13,581 8%
Analysis of Financial Statement Debt/Equity Ratio = Total Liabilities/Shareholders equity = 650474/532302 = 1.22
A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense. In income statement, non-operating expense should not gain tax benefit. It should be deducted from retained earnings.
Thankyou.
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