Case 24-2 (CA24-2) (Disclosures Required in Various Situations) Rem Inc.
produces electronic components for sale to manufacturers of radios,
television sets, and digital sound systems. In connection with her
examination of Rem’s financial statements for the year ended December
31, 2007, Maggie Zeen, CPA, completed field work 2 weeks ago. Ms. Zeen
now is evaluating the significance of the following items prior to
preparing her auditor’s report. Except as noted, none of these items
have been disclosed in the financial statements or notes.
Item 1
A 10-year loan agreement, which the company entered into 3 years ago,
provides that dividend payments may not exceed net income earned after
taxes subsequent to the date of the agreement. The balance of retained
earnings at the date of the loan agreement was $420,000. From that date
through December 31, 2007, net income after taxes has totaled $570,000
and cash dividends have totaled $320,000. On the basis of these data,
the staff auditor assigned to this review concluded that there was no
retained earnings restriction at December 31, 2007.
Item 2
Recently Rem interrupted its policy of paying cash dividends quarterly
to its stockholders. Dividends were paid regularly through 2006,
discontinued for all of 2007 to finance purchase of equipment for the
company’s new plant, and resumed in the first quarter of 2008. In the
annual report dividend policy is to be discussed in the president’s
letter to stockholders.
Item 3
A major electronics firm has introduced a line of products that will
compete directly with Rem’s primary line, now being produced in the
specially designed new plant. Because of manufacturing innovations, the
competitor’s line will be of comparable quality but priced 50% below
Rem’s line. The competitor announced its new line during the week
following completion of field work. Ms. Zeen read the announcement in
the newspaper and discussed the situation by telephone with Rem
executives. Rem will meet the lower prices that are high enough to cover
variable manufacturing and selling expenses but will permit recovery of
only a portion of fixed costs.
Item 4
The company’s new manufacturing plant building, which cost $2,400,000
and has an estimated life of 25 years, is leased from Ancient National
Bank at an annual rental of $600,000. The company is obligated to pay
property taxes, insurance, and maintenance. At the conclusion of its
10-year noncancellable lease, the company has the option of purchasing
the property for $1. In Rem’s income statement the rental payment is
reported on a separate line.
Instructions
For each of the items above discuss any additional disclosures in the
financial statements and notes that the auditor should recommend to her
client. (The cumulative effect of the four items should not be
considered.)
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