Question

Case 7-1: The following financial statement was prepared by employees of your client, Linus Construction Company.

Linus Construction Company Statement of Financial Position December 31, 2017
Current Assets:
Cash			$ 182,200
Accounts receivable (less allowance of $14,000 for doubtful accounts)			220,700
Materials, supplies, labor, and overhead charged to construction			2,026,000
Materials and supplies not charged to construction			288,000
Deposits made to secure performance of contracts			360,000	$3,076,900
Less Current Liabilities:
Accounts payable to subcontractors			$ 141,100
Payable for materials and supplies			65,300
Accrued payroll			8,260
Accrued interest on mortgage note			12,000
Estimated taxes payable			66,000	292,660
Net working capital				$2,784,240
Property, Plant, and Equipment (at cost):
	Cost	Depreciation	Value
Land and equipment	$ 983,300	$310,000	$ 673,300
Machinery and equipment	905,000	338,000	567,000
Payments made on leased equipment	230,700	230,699	1
	$2,119,000	$878,699	$1,240,301
Deferred Charges:
Prepaid taxes and other expenses			11,700
Points charged on mortgage note			10,800	1,262,801
Total net working capital and noncurrent assets				$4,047,041
Less Deferred Liabilities:
Mortgage note payable			300,000
Unearned revenue on work in progress			1,898,000	2,198,000
Total net assets				$1,84,0411
Stockholders’ Equity:
6% preferred stock at par value			$400,000
Common stock at par value			800,000
Paid‐in surplus			210,000
Retained earnings			483,641
Treasury stock at cost (370) shares)			(44,000)
Total stockholders’ equity				$1,849,041

The statement is not accompanied by footnotes, but you have discovered the following:

• The average completion period for the company’s jobs is 18 months. The company’s method of journalizing contract transactions is summarized in the following pro forma entries.
• Linus both owns and leases equipment used on construction jobs. Typically, its equipment lease contracts provide that Linus may return the equipment upon completion of a job or may apply all rentals in full toward purchase of the equipment. About 70 percent of lease rental payments made in the past have been applied to the purchase of equipment. While leased equipment is in use, rents are charged to the account payments made on leased equipment (except for $1 balance) and to jobs on which the equipment has been used. In the event of purchase, the balance in the payments made on leased equipment account is transferred to the machinery and equipment account, and the depreciation and other related accounts are corrected.
• Management is unable to develop dependable estimates of costs to complete contracts in progress.

Required:

1. Identify a weaknesses in the above financial statement (there are at least 15).
2. Find another weakness and indicate a preferable accounting treatment and explain why the treatment is preferable .
3. Which of the weaknesses do you think are the most serious and why?

Answer 1

a. While there remains multiple weaknesses in the given Financial Statement, we can state, for one, re the Net Assets not matching with the Stockholders' equity. Apart from the mistakes and irregularities, it points to the fact that the Statement is incomplete and incorrect. There are more and/or different amounts than are stated on the fact of the Statement.

b. Another weakness that we can point out is re the 'Prepaid Taxes and Other Expenses' being classified under Deferred Charges outside of Working Capital. This is typically a Current Asset item and should form a part of the Working Capital. Prepaid Taxes are of the current nature as they remain adjustable against the current period tax liability.

c. The major weaknesses are ---

-- Balance Sheet not matching, as discussed in a above. This clearly indicates missing and/or incorrect information presented

-- Incorrect classification of items in Current Assets. This creates a wrong idea of Working capital.