USING CODIFICATION
C13-13 Researching GAAP
Situation
On December 31, 2013, Phelps Company, owned an investment portfolio that consisted of
several debt securities that were appropriately classified as available-for-sale. However, a
review of this investment portfolio indicated that one particular investment in the bonds of
Lochte Inc. had exhibited a significant decline in value. Specifically, this investment, which had
been purchased 3 years ago, had an amortized cost of $3,800,000 but a fair value of only
$2,500,000. As the accountant for Phelps, you suspect that the investment may be impaired and
decide to further investigate the causes of this decline in value. Your investigation revealed that
the fair value of the Lochte investment had been below its amortized cost for the past 15 months,
and the management of Phelps attributed this decline in value to interest rate increases. Further,
Phelps management states it does not intend to sell the Lochte investment as of December 31,
2013, nor do they believe that they will be required to sell the investment prior to recovering the
amortized cost basis of the investment. In addition, Lochte has made all interest and principal
payments as scheduled and Phelps has no reason to believe that it will not continue to do so. The
president of Phelps asks you if an impairment loss needs to be recognized in its 2013 financial
statements.
Directions
1. Research the related generally accepted accounting principles and prepare a short memo to
the president of Phelps that answers his question. Cite your references and applicable
paragraph numbers.
2. Would your answer change if Phelps sold some of the Lochte shares in February 2014, prior
to the release of the 2014 financial statements?
C 13-14 Researching GAAP
Situation
You are auditing New Generation Company when you come across a note receivable signed by
the president of a company that is a major supplier. The note has a face value of $100,000, is
payable to New Generation, is dated January 1, 2013, and is payable January 1, 2016. The
interest rate on the note is 1%. You ask the president of New Generation about the note and she
responds “That is fine. We lent him some money to help him through a difficult divorce. We
wanted him to pay interest, but he couldn’t afford the going rate of 8%. So how do you think we
should account for the note?”
Directions
1. Research the related generally accepted accounting principles and prepare a short memo to
the president that answers her question. Cite your references and applicable paragraph
numbers.
2. How would your answer change if the interest rate on the note was 16%?
3. Do these valuation issues also create ethical issues?
C13-15 Researching GAAP
Situation
Yorkshire Company has a $90,000 non-interest-bearing, four-year note receivable from the
Middleton Company that was received on July 1, 2013, when Yorkshire sold a used machine.
The machine was custom made five years ago, cost Yorkshire $100,000, and was being
depreciated over a 10-year life by the straight-line method to a zero residual value. As the
accountant for Yorkshire you know that GAAP requires that the note be discounted using the
borrower’s interest rate. You phone the accountant for Middleton and ask her what that
company’s incremental borrowing rate is. She responds cheerfully, “Sorry, I have no idea. We
never borrow money because the owner provides all the capital we need.” The president asks you
to resolve this issue.
Directions
Research the related generally accepted accounting principles and prepare a short memo to the
president that answers her question. Cite your references and applicable paragraph numbers.