The Effect of Accounting Choices on Reported Results Sunlight Incorporated and Moonbeam Enterprises both began operations on the first day of 2004. Both operate in the same industry, sell the same products, and have many of the same customers. Both companies have just reported financial results at the end of 2004. By a remarkable coincidence, the sales revenue reported by both companies was exactly the same.
Overall, however, Moonbeam’s net income was approximately 75% greater than Sunlight’s. You are a little surprised by this because it was generally thought by those in the industry that Sunbeam had been the better managed and more successful firm.
|
Income Statements for Year 2004 |
Sunlight Incorporated |
Moonbeam Enterprises |
|
Sales revenue |
$31,000 |
$31,000 |
|
Cost of goods sold |
20,000 |
18,600 |
|
Gross profit |
$11,000 |
$12,400 |
|
Operating expenses: |
||
|
Depreciation |
1,100 |
1,100 |
|
Insurance |
550 |
610 |
|
Supplies |
1,300 |
1,300 |
|
Uncollectible accounts |
1,240 |
310 |
|
Warranties |
620 |
0 |
|
Wages |
1,500 |
1,570 |
|
Total operating expenses |
6,310 |
4,890 |
|
Operating income |
4,690 |
7,510 |
|
Interest expense |
900 |
900 |
|
Pretax income |
3,790 |
6,610 |
|
Income tax expense |
1,298 |
2,314 |
|
Net income |
$2,492 |
$4,296 |
|
Earnings per share |
$1.25 |
$2.15 |
Upon reviewing the notes that accompany the financial statements, however, you observe the following.
1. At year end, Sunlight recorded allowances in its accounting system for expected sales discounts (of $113) and expected sales returns ($1,345). Moonbeam, while having the same types of products and customers, did not believe it had enough information to record estimates after only one year in business.
2. Both companies reported sales totaling 1,200 units. Sunlight recognizes revenue when goods are shipped to customers. Moonbeam recognizes revenue when the order is received. As of year end, the last 100 units that Moonbeam has reported as sales have not yet been shipped to customers because Moonbeam is temporarily out of stock. An employee forgot to re order the item on time and now the manufacturer’s plant is down for annual maintenance at year end. Production is scheduled to resume on January 15.
As soon as these units are received at Moonbeam’s warehouse, they will be shipped to the customers who ordered them.
3. Moonbeam used the perpetual FIFO method of inventory estimation, but Sunlight used perpetual LIFO. Both companies had the same inventory costs and reported inventory transactions as follows.
|
Event |
Units |
Cost per Unit |
Total Cost |
|
Beginning inventory |
0 |
$0 |
$0 |
|
Purchase |
200 |
12 |
2,400 |
|
Purchase |
500 |
15 |
7,500 |
|
Sales |
300 |
||
|
Purchase |
400 |
17 |
6,800 |
|
Sales |
500 |
||
|
Purchase |
300 |
19 |
5,700 |
|
Sales |
300 |
||
|
Sales* |
100 |
*As the wholesale cost of goods increased during the year, both firms increased selling prices, too. This last batch of sales (as reported by each firm) was sold at $30 per unit. Unlike other sales, this batch of goods was sold for cash and no returns were allowed.
4. At year end, both companies were concerned about uncollectible accounts. Being new in the business, neither firm had much history upon which to base an estimate. Nevertheless, Sunlight estimated that approximately 4% of sales would be uncollectible. Moonbeam was more optimistic and estimated the rate at only 1%.
5. The companies differ in how they account for warranty expenses. Sunlight’s management estimated the cost of future warranty claims (for goods sold during the year just ended) and recorded an expense for that amount. Moonbeam decided that the amount would be immaterial and it would just charge these claims to expense in the later years when they were paid.
Required Which firm had the better financial results for its first year of operation? Why? Prepare any tables or schedules that you think would support your conclusion or be helpful to illustrate the basis for your conclusion.