ISSUES IN ACCOUNTING EDUCATION
Vol. 27, No. 2
2012
pp. 493–524
American Accounting Association
DOI: 10.2308/iace-50124
How Adjusting Entries Affect the Quality of
Financial Reporting: The Case of Frosty Co.
Jason C. Porter
ABSTRACT: Recent accounting scandals have emphasized the need to think beyond
debits and credits. Accounting students must understand the effects of transactions on a
company’s financial position, as well as the pressures and incentives they will someday
face to misrepresent that position. This case introduces students in intermediate financial
accounting courses to both of these important objectives. First, the case improves
students’ critical thinking skills in accounting by allowing them to determine if various
correcting entries should be made, and what the effects of those transactions will be on
the company’s financial statements. Second, the case improves students’ ability to
evaluate ethical consequences by introducing them to conflicting incentives regarding
those corrections: the obligation to provide investors with high-quality financial statements
that fairly present the company’s financial position versus the pressure to maintain a high
stock price for investors. The case may be completed using either U.S. GAAP or IFRS.
Keywords: adjusting entries; financial statement adjustments; accounting cycle; ratio
analysis; IFRS.
BACKGROUND INFORMATION
F
rosty Co. is a publicly traded, medium-sized manufacturing firm that produces refrigerators,
freezers, ice makers, and snow cone machines. During the past three years, the company has
struggled against increasing competition, sluggish sales, and a public relations scandal
surrounding the departure of the former Chief Executive Officer (CEO) and Chief Financial Officer
(CFO). The new CEO, Jane Mileton, and CFO, Doug Steindart, have worked hard to improve the
company’s image and financial position. After several difficult years, the company now seems to be
resolving its difficulties, and the management team is considering new investment opportunities.
The team hopes that diversification into a line of professional ice cream makers, and perhaps a line
of consumer products, will help the company continue its recent growth and effectively compete
with future competitors.
In order to raise the funds needed for these new investments, Frosty Co.’s Board of Directors
has approved a seasoned equity offering (SEO). The discussions regarding the new investment
opportunities and the equity offering have been kept quiet until a positive set of financial statements
Jason C. Porter is an Associate Professor at the University of Idaho.
I appreciate the comments of Marla Kraut, Teresa Gordon, Jeff Michelman, Angela Spencer, Michele O’Neill, and
workshop participants at the 2007 Northwestern Accounting Research Group and the 2009 AAA Annual Meeting. I am
also grateful for the comments and suggestions of the associate editor and reviewers.
Published Online: January 2012
493
Porter
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can provide strong evidence that the company has turned around, leading to an increase in the
company’s stock price.
INTRODUCTION
After a full week of carefully examining financial statements, Simon was exhausted. He had
become Frosty Co.’s corporate controller only a month ago, after several years as an auditor at a
public accounting firm, and was excited about the move to corporate accounting. The first few
weeks had gone well, as Simon met his accounting staff and settled into his new responsibilities.
Then, he had started reviewing Frosty Co.’s financial statements for the prior year to make sure they
correctly followed GAAP, and to familiarize himself more with the company and industry.
Unfortunately, his relative inexperience with the industry and Frosty’s accounting procedures had
required him to spend more time on the review than he had anticipated.
He still had a few questions about the financial statements, but he needed to start preparing for
the upcoming SEO. He decided that he would talk to his staff about his lingering questions
tomorrow morning, just before his meeting with the CEO and CFO. The three of them were to
discuss the upcoming audit and the earnings announcement and how they would impact the
proposed SEO. He rubbed his tired eyes and headed home to get a little sleep.
MEETING OF THE ACCOUNTING STAFF: 10:30AM
Simon looked up as the divisional controllers, Elsa Pilebody and John Mortenson, came into
his office. Elsa worked with Frosty Co.’s fridge and freezer division; John worked with the ice
maker and snow cone machine division. So far, Simon had enjoyed working with them, especially
since neither of them seemed to resent him stepping in as their new boss. They were both smiling as
they came through the door, and their good-natured teasing started almost before they had finished
shaking hands.
‘‘Sorry we’re a little late,’’ Elsa started, ‘‘but John had to stop for the last jelly donut.’’
‘‘I did not!’’ John said indignantly. He looked at Simon. ‘‘It was chocolate.’’
Because of his busy schedule that day, Simon got down to business instead of joining the
banter as he normally would have done. ‘‘Thanks for coming by, Elsa and John. We have several
issues to discuss before I have to meet with Jane and Doug this afternoon.’’ He paused for a second.
‘‘I’ve spent the past week going over the financial statements. Overall, they look well done, but I
need clarification on a few details. To start with, I want to discuss the construction project we began
last year.’’
‘‘That’s our big project at the moment. We’re building a new factory that should be done next
summer,’’ Elsa said. ‘‘Construction is going well, and we’ve been careful to capitalize all of the
expenditures.’’
Simon shook his head. ‘‘That’s the problem. I think we capitalized more than we should have.
More specifically, it looks like we capitalized all of the interest on our most recent bank loan.’’
‘‘We did,’’ Elsa replied. ‘‘Since we’re using all of the loan proceeds to build the new factory,
we felt it was appropriate to capitalize all of the interest.’’ John nodded in agreement.
‘‘I disagree,’’ said Simon. ‘‘Here’s a breakdown of the payments we made on our new building
and a list of our outstanding long-term debt (see Table 1). Did we take out any of these loans
specifically for the new factory?’’
Elsa shook her head. ‘‘No, we took out the new loan, Loan 2, for general expansion, then
decided the most appropriate use of the funds would be for the new factory.’’
Simon frowned. ‘‘Why are we capitalizing the interest on Loan 2 if it wasn’t originated
specifically for the new factory?’’
Issues in Accounting Education
Volume 27, No. 2, 2012
How Adjusting Entries Affect the Quality of Financial Reporting: The Case of Frosty Co.
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TABLE 1
Avoidable Interest Information
Panel A: Construction Payments on the New Factory
Payment Date
Amount
Feb. 15
Apr. 1
Jun. 30
Oct. 1
Nov. 15
$90,000
$125,000
$200,000
$300,000
$585,000
Panel B: Long-Term Debt Information
Type of Debt
Bond A
Loan 1
Loan 2
Amount
Interest Rate
$678,500
$650,000
$1,000,000
7.1%
6.0%
7.0%
‘‘Well, if the capital from the loan is eventually used on a specific construction project, then I
think we should be able to capitalize the interest on that loan as part of the historical cost of the
project. Of course,’’ Elsa frowned, ‘‘maybe we are capitalizing too much. Perhaps we need to
calculate avoidable interest to determine the amount of interest that should be capitalized.’’
‘‘You are right that generally we would need to calculate avoidable interest before capitalizing
any interest,’’ Simon answered. ‘‘But in this case, we don’t need to do that. I believe GAAP allows
interest to be capitalized only if a specific construction loan is used.’’
‘‘Well, I still think that we should be able to capitalize at least some of the interest. But I’ll do
some research to make sure.’’
‘‘You said that you had questions about other things, too?’’ John asked.
‘‘Yes,’’ Simon said. ‘‘I am curious about one other issue. This year, we introduced a new line of
industrial snow cone machines.’’
‘‘Yes, we did,’’ John replied quickly. ‘‘And we were very careful with all of the sales and
expense transactions.’’
‘‘Yes, you were, but didn’t the new model replace an older version?’’
‘‘Yes,’’ John replied, and then frowned. ‘‘The first model was replaced because of some slight
design problems. It worked well, but the customers didn’t like the way it looked or sounded. We
shouldn’t have any liability issues because of those old machines.’’
‘‘I’m not worried about warranty or liability issues. I believe those have been properly
recorded. However, we still have some of those original units in inventory, right?’’
‘‘Only a few dozen, I believe. Is that a problem?’’
‘‘It is since we still have those units recorded at their original historical cost. Now that we have
a new model, the value of those old machines has probably dropped significantly.’’
Elsa nodded. ‘‘That’s a good point. Who would buy the old version now that a newer version is
available? We probably need to write down that inventory.’’
John sighed. ‘‘Okay, but to do the calculations, I’ll need some data about current sales price,
replacement values, and disposal costs.’’
Simon handed John a table (see Table 2). ‘‘I called the production and sales departments this
morning and got everything you need.’’
Issues in Accounting Education
Volume 27, No. 2, 2012
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TABLE 2
Inventory Information
(Snow Cone Machine WQ-567)
Current Sales Price
Historical Cost
Replacement Cost
Disposal Cost
Typical Markup
Units in Inventory
Estimate 1
Estimate 2
$750
$850
$700
$65
$200
62
$600
$850
$500
$70
$175
62
John studied the table for a minute. ‘‘There are two sets of estimates here.’’
Simon nodded. ‘‘I’m afraid so. The two managers couldn’t agree on the estimates. The first set
comes from Todd, the sales manager. The second set comes from Nate, the line manager for the
snow cone machine line. My guess is that Nate has a better feel for the production costs involved,
but Todd’s estimates of the current sales price are probably more accurate.’’
Frowning even more, John said, ‘‘Nate’s estimates will probably require a larger write-down.’’
‘‘Which will be a harder sell to the management team,’’ Elsa said. ‘‘They really want to report
strong financial statements for the stock offering.’’
‘‘I know, but I don’t think we should base our decision on which estimates provide a smaller
write-down,’’ Simon cautioned. ‘‘If we are going to write down inventory, then we need to use the
most accurate estimates. However, in order to decide which set of estimates to use, I think we will
need to see the results from each set. I’m sorry, John, but I need you to do the calculations twice.’’
John nodded.
‘‘Well,’’ Simon said. ‘‘Those were my questions. Do either of you have any concerns we need
to discuss before I meet with Jane and Doug?’’
Elsa had a pensive look on her face. ‘‘I think we need to consider recognizing an asset
retirement obligation, or ARO, for the new factory. Our lease agreement with the city states that we
will clean up the land, if necessary, when we close down the factory. When we originally prepared
the financial statements, we didn’t have enough information to estimate the ARO, so we only
disclosed the requirement in the footnotes.’’
‘‘I saw that,’’ Simon replied. ‘‘It looked like the note was well done.’’
‘‘Thanks. However, last week we received a letter from the city. It seems that city officials
recently hired an engineer with quite a bit of experience cleaning up after factories like ours. She
believes there is a 70–75 percent chance that we will have to clean up the land at the end of our
lease, and she sent us a letter including her estimate of the future cost. She wanted to make sure that
we were prepared to handle those costs when our lease runs out in 20 years.
‘‘When I first got the letter, I decided that since it arrived after the close of the fiscal year, we
could wait and record it this year. However, if we’re going to go back and change the amount of
interest capitalized on the factory, shouldn’t we also record the associated ARO?’’
Simon thought for a moment. ‘‘I don’t know. We did receive the information before releasing
our financial statements, but there’s only a 70–75 percent chance that we will actually have an
obligation. Do we need to include that estimate?’’
‘‘Do you remember how much it was?’’ John asked.
Elsa nodded. ‘‘The city engineer believes it will cost $500,000 just to tear down the factory in
20 years.’’
Issues in Accounting Education
Volume 27, No. 2, 2012
How Adjusting Entries Affect the Quality of Financial Reporting: The Case of Frosty Co.
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‘‘Well, when you consider our 12 percent internal rate of return, the ARO won’t be too big,’’
John said, smiling.
‘‘You’re right.’’ Elsa nodded. ‘‘That part doesn’t sound too bad. However, she also estimates
that we will need to spend approximately $250,000 a year for the three years after removing the
plant to restore the land to its original condition.’’
‘‘Thanks for bringing that up, Elsa,’’ Simon said. ‘‘Do you have any other concerns?’’
‘‘Just one,’’ John said, ‘‘and it’s only an idea that you might want to pitch to the management
team along with these other changes. We have used the percent of accounts receivable method to
calculate our Allowance for Bad Debt for several years. But we don’t have to use that method.’’
‘‘What do you mean?’’ Elsa asked. ‘‘Isn’t the percent of accounts receivable method one of the
best ways to calculate the Allowance?’’
‘‘Technically, yes, it is. However, we recently hired a new credit manager who has improved
our collections and tightened our credit policy for new customers. Because of these improvements,
we might not have to use the percent of accounts receivable method. Instead, we could switch back
to the percent of sales method that we used previously. By switching from using 12 percent of
accounts receivable to 2 percent of credit sales, we would reduce our allowance for bad debts and
our bad debt expense. That would offset some of these negative changes we have just discussed.’’
‘‘What were credit sales for the year?’’ Simon asked.
‘‘About $1.25 million, and accounts receivable had an ending balance of $600,000 after we
wrote off $30,000 of uncollectible accounts. We wrote off almost $50,000 the year before, so our
collections really have improved. Honestly, I don’t think that we’d lose information quality by
switching methods. We don’t really have to use any specific method for estimating bad debt
expense. I think we could make a case for the more relaxed estimation method, and I think the
positive effect of the change on net income might help the management team accept some of these
other adjustments.’’
Elsa jumped in. ‘‘I don’t see any problem with that.’’
Simon frowned. ‘‘I’m not sure I like the idea of changing methods solely to offset the negative
effects of these other adjustments. But go ahead and calculate how switching methods would affect
our bad debt expense. We’ll meet again tomorrow morning, after I’ve talked with Jane and Doug
about how to handle these issues.’’
MEETING WITH THE CEO AND CFO: 2:00PM
Jane, Frosty Co.’s CEO, shook Simon’s hand as she welcomed him into her office. Doug, the
CFO, was already seated. ‘‘So, how do things look?’’ Jane asked as Simon took his seat.
‘‘Well,’’ said Simon, as he handed out copies of the financial statements (see Tables 3–5).1 ‘‘I
think the financial statements will be ready for our audit and our earnings announcement on
schedule.’’
Jane frowned as she flipped through the statements. ‘‘That’s great, Simon, but how do things
look?’’
Simon looked confused, so Doug explained. ‘‘I think Jane wants to know the final EPS.’’ Doug
glanced quickly at the financial statements, then turned to Jane and said, ‘‘It looks like EPS will be
$2.21. That’s five cents higher than the analysts’ $2.16 forecast.’’
‘‘Well,’’ Simon said slowly.
‘‘Perfect!’’ Jane said brightly, ignoring him. ‘‘That’s just what I wanted to hear!’’
‘‘But . . .’’ Simon tried again.
1
Tables 3, 4, and 5 present Frosty Co.’s original financial statements using U.S. GAAP. A set of financial
statements using IFRS is available in Appendix A.
Issues in Accounting Education
Volume 27, No. 2, 2012
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TABLE 3
Income Statement
Frosty Co.
Income Statement
For the Year Ended December 31, Year 2
Sales Revenue
Sales Revenue
Less: Sales Discounts
Sales Returns and Allowances
Net Sales Revenue
Cost of Goods Sold
Inventory, Dec. 31, Year 1
Purchases
Less: Purchase Discounts
Purchase Returns
Purchase Allowances
Net Purchases
Freight In
Cost of Merchandise Available for Sale
Less: Inventory, Dec. 31, Year 2
$4,452,300
$44,523
$25,000
$4,382,777
$495,600
$1,850,000
$37,000
$92,500
$18,500
$1,702,000
$61,500
$1,763,500
$2,259,100
$775,000
Cost of Goods Sold
$1,484,100
Gross Profit
Operating Activities
Advertising Expense
Bad Debt Expense
Depreciation Expense
Insurance Expense
Miscellaneous Expense
Supplies Expense
Utilities Expense
Wages Expense
Warranty Expense
$2,898,677
$445,230
$62,000
$782,500
$92,000
$97,205
$52,450
$97,800
$355,000
$39,950
Total Operating Expenses
Income from Operations
Other Gains and Losses
Rent Revenue
Interest Expense
Loss on Sale of Machinery
$69,523
$2,024,135
$874,542
$70,000
($87,174)
($67,500)
($84,674)
Income before Income Taxes
Income Tax Expense (30%)
$789,868
($236,960)
Net Income (Loss) for Year 2
$552,908
EPS (250,000 shares outstanding)
$2.21
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Volume 27, No. 2, 2012
How Adjusting Entries Affect the Quality of Financial Reporting: The Case of Frosty Co.
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TABLE 4
Balance Sheet
Frosty Co.
Balance Sheet
As of December 31, Year 1, and December 31, Year 2
Assets
Current Assets
Cash
Accounts Receivable
(Allowance for Doubtful Accounts)
Inventory
Prepaid Advertising
Prepaid Insurance
Total Current Assets
Year 2
Year 1
$85,050
$600,000
($72,000)
$775,000
$90,000
$25,000
$75,000
$350,000
($40,000)
$495,600
$105,000
$45,000
$1,503,050
$1,030,600
$1,250,000
$8,870,000
$11,000,000
($7,582,500)
$1,250,000
$7,500,000
$10,500,000
($6,800,000)
Total PPE
Intangible Assets
Goodwill
$13,537,500
$12,450,000
$3,250,000
$3,250,000
Total Assets
$18,290,550
$16,730,600
$433,659
$186,390
$60,000
$77,193
$325,000
$750,000
$57,500
$40,000
$52,000
$255,000
$1,082,242
$1,154,500
$1,650,000
$678,500
$650,000
$678,500
$2,328,500
$1,328,500
$3,410,742
$2,483,000
$5,104,300
$125,000
($11,000)
$9,661,508
$5,000,000
$50,000
($11,000)
$9,208,600
PPE
Land
Building
Machinery
(Accum Depr)
Liabilities and Stockholder’s Equity
Current Liabilities
Accounts Payable
Income Tax Payable
Interest Payable
Other Payables
Unearned Sales Revenue
Total Current Liabilities
Long-Term Debt
Loans Payable
Bonds Payable
Total Long-Term Liabilities
Total Liabilities
Stockholders’ Equity
Additional Paid-In Capital
C-stk, $0.50 par
Treasury Stock ($11 par; 1,000 shares)
Retained Earnings
Total Equity
$14,879,808
$14,247,600
Total Liabilities and Equity
$18,290,550
$16,730,600
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TABLE 5
Statement of Cash Flows
Frosty Co.
Statement of Cash Flows
For the Year Ended December 31, Year 2
Cash Flows from Operating Activities
Net Income
Adjustments to Accrual-Basis Net Income
Increase in Accounts Receivable, net
Increase in Unearned Revenue
Increase in Inventory
Decrease in Accounts Payable
Decrease in Prepaid Advertising
Depreciation
Decrease in Prepaid Insurance
Increase in Interest Payable
Increase in Other Payables
Loss on Sale
Increase in Income Tax Payable
Net Cash Flows from Operating Activities
Cash Flows from Investing Activities
Sale of Machinery
Purchase of Machinery
Construction of Building
Net Cash Flows from Investing Activities
Cash Flows from Financing Activities
Cash from Sale of Stock
Cash from New Loan
Cash Paid as Dividends
Net Cash Flows from Financing Activities
$552,908
($218,000)
$70,000
($279,400)
($316,341)
$15,000
$782,500
$20,000
$20,000
$25,193
$67,500
$128,890
$315,342
$868,250
$477,500
($1,065,000)
($1,350,000)
($1,937,500)
$179,300
$1,000,000
($100,000)
$1,079,300
Net Increase in Cash
Cash on hand, Jan. 1, Year 2
$10,050
$75,000
Cash on hand, Dec. 31, Year 2
$85,050
‘‘Right,’’ Doug agreed. ‘‘Let’s go ahead and announce the SEO right away.’’
‘‘Good idea,’’ Jane said, nodding. ‘‘There’s no reason to wait if we’ve got good news.’’
‘‘Excuse me,’’ Simon jumped in. ‘‘But that might be a little premature.’’
Jane looked at him. ‘‘Why?’’
‘‘Well, I do have a couple of issues I need to discuss with you.’’
Doug and Jane both frowned. ‘‘What do you mean?’’ Doug asked slowly.
Simon sat forward. ‘‘I met with my team this morning, and we think there may be a few
corrections that need to be made to this draft of the financial statements.’’
‘‘I thought you said they were done,’’ Jane snapped.
Doug held up his hands. ‘‘Jane, don’t shoot the messenger. It’s Simon’s job to look through the
financial statements for any problems.’’
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Jane took a deep breath. ‘‘You’re right.’’ She sighed. ‘‘I’m sorry, Simon. What have you
found?’’
Simon took a deep breath. ‘‘First, we capitalized all of the interest on our new loan as part of
our construction project. According to GAAP, we might be able to capitalize some of that interest,
but certainly not all of it. Second, officials from the city where the new factory is being built have
provided us with fairly accurate estimates of what we will need to spend to remove the factory and
clean up the land when our lease expires. Since we haven’t released the financial statements yet, we
may need to record the ARO.’’ Jane grimaced, but Simon pushed on. ‘‘Third, we haven’t written
down any of our obsolete inventory following the introduction of the new snow cone machine line,
and we know that our customers aren’t going to buy the earlier model at the original price. We’re
still looking into how much the write-down will be, but we will need to write down some of it.’’
Jane asked quietly, ‘‘Are you finished?’’
‘‘Those are the issues we’ve identified. I’m not sure what the net effect of the changes will be
yet, but I’m afraid that they might drop EPS quite a bit.’’
‘‘But . . .’’ Jane said hotly.
Doug jumped in. ‘‘Look, Simon, I know you want to correctly account for all of these issues; I
do too, but we need a strong set of financials this year. We’re counting on that SEO to fund our new
growth strategies. We need the good news now, so leave the statements as they are. We’ll fix all of
these issues after the offering, I promise.’’
Simon said quietly, ‘‘I think we need to make these adjustments, all of them.’’ He looked at
Jane’s angry face. ‘‘There is a way to reduce the drop in EPS. We could switch our method of
calculating bad debt expense from the percent of accounts receivable method to the percent of credit
sales method.’’
Jane played with her earring while she thought. ‘‘Would switching methods offset the other
adjustments?’’
Simon shook his head. ‘‘Probably not entirely, but it will help.’’
Jane shook her head. ‘‘Simon, just leave the financial statements as they are.’’
Simon started to argue, but Jane cut him off. ‘‘Look, Simon, the decision is mine to make, and
I’m telling you: don’t mess with the financial statements. Leave them as they are!’’
‘‘But the statements are wrong as they are!’’
‘‘We don’t know that,’’ Doug jumped in quickly. ‘‘All we really know is that maybe we should
do something about these issues. Think about the inventory adjustment for a minute. Companies
leave obsolete inventory on their books all the time, waiting for a good year to write them down. It
doesn’t really bother anyone. And as far as the interest capitalization, if the auditors don’t catch it
. . .’’
‘‘But our numbers will be wrong!’’
Jane sounded exasperated. ‘‘You don’t know that, Simon. There are so many estimates in the
financial statements that you can’t ever be sure if the numbers are right or wrong. Besides, we owe
it to our investors to report good numbers; that’s how their investments grow. Believe me, they
don’t want to see bad numbers. So, if the auditors happen to stumble on these issues.. . .’’ She
stopped for a moment, looking at Simon’s face. ‘‘If the auditors stumble on them, send them to talk
to Doug or to me. We’ll straighten them out.’’ She smiled. ‘‘Don’t worry about this so much. Just
leave things as they are, and we’ll take care of you when bonuses come out. The Board’s going to
be thrilled to see these financial statements, and we’ll be sure to tell them how much you helped us
get ready for the SEO. We’re always happy to reward . . . team players.’’ Doug nodded. ‘‘I think
that’s everything for today. Thank you for all of your hard work.’’
Simon stood, picked up his papers, and headed for the door. When they had hired him, he had
been excited for a new opportunity. But now, he was starting to wonder if he should have stayed in
public accounting.
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CASE REQUIREMENTS
1. Capitalizing interest on the new factory:
a. During the year, Frosty Co. paid all of the interest accrued on Bond A and Loan 1, but
only $50,000 of the interest accrued on Loan 2. Using one journal entry, summarize how
Frosty originally recorded the accrued interest on all three long-term debts.
b. Assuming John and Elsa are right that the new loan meets the standards for capitalizing
interest, calculate avoidable interest.
c. What correcting entries would need to be made to properly record interest on Frosty
Co.’s construction project if John and Elsa are right? (Hint: Assume that Frosty Co.’s
income tax rate is 30 percent. Any necessary changes to taxes should be recorded to
Income Tax Expense and Income Tax Payable.)
d. What correcting entries would need to be made to properly record interest on Frosty
Co.’s construction project if Simon is right?
e. What would be the net effect of each of these interest adjustments on net income? What
would be the net effect on EPS?
2. Recording the asset retirement obligation (ARO) on the new plant:
a. Assuming that payments will be made at the end of each year, determine the amount that
Frosty Co. should recognize for the ARO.
b. Assuming Frosty Co.’s management team decides to record the ARO, what correcting
entries would need to be made?
c. What would be the net effect of the ARO adjustment on the current year’s net income?
What would be the net effect on EPS?
3. Recording the write-down on obsolete inventory:
a. Based on the information provided in Table 2, calculate the write-down that would be
necessary using the first set of assumptions.
b. Based on the information provided in Table 2, calculate the write-down that would be
necessary using the second set of assumptions.
c. Assuming that Frosty Co.’s management team decided to use the first set of estimates,
what correcting entries would need to be made to write down inventory? (Assume that
Frosty Co. uses the direct write-off method.)
d. What correcting entries would need to be made to write down inventory if the team
decided to use the second set of estimates?
e. What would be the net effect of each of these inventory adjustments on net income?
What would be the net effect on EPS?
4. Recording the change from the percentage of sales to the percentage of accounts receivable
method of calculating bad debt expense:
a. Calculate the amount of bad debt expense Frosty Co. would recognize using the
percentage of sales method.
b. Assuming that the management team has decided to switch from the percent of accounts
receivable method to the percent of sales method for estimating bad debt expense, what
correcting entries would need to be made?
c. What would be the net effect of this change in method on net income? What would be
the net effect on EPS?
5. Evaluating each adjustment:
a. Based on the accounting standards, can Frosty Co. capitalize the interest on the
construction project? If so, how much can Frosty Co. capitalize? Explain.
b. Based on the accounting standards, does Frosty Co. need to recognize the ARO in these
financial statements? Explain.
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c. Based on the discussion in the case, which set of lower of cost or market assumptions do
you think is the most appropriate? Explain.
d. Do you think that Frosty Co. should switch methods of calculating bad debt expense?
Explain.
6. Updating Frosty Co.’s financial statements:
a. Based on the correcting entries you made in Questions 1–4 and your answers to Question
5, make any necessary changes to Frosty Co.’s income statement (see Table 3). Your
new Income Statement should include four simple footnotes summarizing how you
chose to treat each of the four adjustments.
b. Based on your correcting entries and your changes to the income statement, make any
necessary changes to Frosty Co.’s balance sheet (see Table 4).
c. If necessary, update Frosty Co.’s statement of cash flows (see Table 5).
7. Analyzing the consequences of your adjustments (round your ratio values to three decimal
places):
a. Calculate Frosty Co.’s EPS, Current Ratio, Profit Margin, ROA, and Debt to Equity
Ratio using the original financial statements.
b. Recalculate the ratios using your adjusted financial statements from Question 6.
c. Which set of financial statements do you think the management team would prefer?
Which set would Frosty Co.’s investors prefer? Defend your answers.
8. Resolving the conflict between Frosty Co.’s upper management: Simon (the controller) felt
that three of the issues presented in the case should be resolved immediately. Doug and Jane
(the CFO and CEO) felt that the financial statements should be left alone. Using your
knowledge of GAAP, Frosty Co.’s business goals, the principles of business ethics, and
your answers to Questions 1–7, do the following:
a. Write one to two paragraphs defending Simon’s opinion.
b. Write one to two paragraphs defending Doug and Jane’s position.
c. What do you think the final decision will be? Do you agree with that decision? Why or
why not?
d. Assuming that Jane insists on leaving the books as they are, what do you think Simon
will do? What do you think he should do?
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CASE LEARNING OBJECTIVES AND IMPLEMENTATION GUIDANCE
Learning Objectives
The primary learning objective of this case is for students to demonstrate critical thinking skills
in accounting. The secondary objective of the case is for students to evaluate the ethical issues
involved in creating the financial statements. These two objectives, developing critical thinking
skills and assessing ethical issues, have quickly become two of the most important issues facing
accounting education (AECC 1990; Albrecht and Sack 2000; Copeland 2005).
Critical thinking in accounting, while defined in many ways, essentially refers to the ability to
use accounting and other business knowledge to make decisions or provide information to decision
makers (AICPA 1999; Jenkins 1998). For students, this includes learning how to interpret
transactions: ‘‘The transaction must be analyzed using the accounting equation . . . to determine
which (if any) accounts are affected and the student must at least implicitly consider how the
transaction will affect the financial statements’’ (Kealey et al. 2005, 36). Helping students to think
critically about accounting transactions and the financial statements not only improves their ability
to provide useful information or make financial decisions, but it also improves their ability to retain
the concepts and methods taught in accounting courses (Springer and Borthick 2007). While many
methods have been introduced to teach critical thinking (for example, Camp and Schnader 2010;
Crumbley et al. 1998; Springer and Borthick 2004), the use of unstructured problems and scenarios
similar to what students will see in their future careers is, perhaps, the most effective (Smith 2003).
In this case, students fulfill the primary objective of demonstrating critical thinking skills in
accounting in three ways. First, students must determine whether corrections need to be made to
properly record the four accounting issues raised in the case. More specifically, students must
determine if the company meets the necessary requirements for capitalizing interest, if an ARO
meets the ‘‘probable’’ requirement for reporting contingencies, if the marketing manager or line
manager’s estimates should be used for writing down obsolete inventory, and if it is appropriate,
and ethical, to change the method of estimating bad debt expense to increase net income. Forcing
students to think about when and if adjustments should be made not only improves their
understanding of the GAAP rules behind the adjustments, but also helps them to understand the
ambiguity inherent in the accounting system, something most students do not experience in early
financial accounting classes (Springer and Borthick 2004, 2007). In addition to improving critical
thinking, making the correcting entries also allows students to practice technical accounting skills.
The second way students accomplish the primary objective of the case is by adjusting Frosty
Co.’s financial statements based on the correcting entries they have decided the company needs to
make. In many cases, the teaching of intermediate accounting involves two steps: (1) reviewing the
accounting cycle and the financial statements, and (2) teaching more advanced journal entries.
Using this format, instructors typically assume that students will connect the basic accounting cycle,
covered in their introductory courses and reviewed during the first few weeks of intermediate
accounting, with the more advanced journal entries. We thereby place the burden of learning how
individual entries affect the financial statements directly on the students, rather than guiding them
through the process. However, we need to provide students with the opportunity to understand,
analyze, and practice the effects of different transactions on the financial statements (Senatra 1983).
By providing students with the opportunity to consider the effects of each entry on net income and
EPS, and to adjust the three primary financial statements, this case allows students to understand the
important connections between individual business decisions, the resulting journal entries, and the
financial statements.
The third way students accomplish the primary objective is by evaluating the effects of their
updated financial statements on investor perceptions. This step can also serve as a powerful
motivational tool for non-accounting majors taking an intermediate accounting course. These
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students often feel that accounting is just another hoop to jump through on the way to their nonaccounting degree. However, once students realize that business decisions cause specific journal
entries, which cause changes in the financial statements, which, in turn, change key financial ratios,
they begin to look at accounting in a whole new light. Instead of a random set of rules and numbers,
accounting becomes an important factor in their future business careers.
Ethics in accounting has become an ever more important topic since the 1970s, when major
accounting scandals first began to reduce the credibility of the accounting profession (Zeff 2003).
Since that time, the accounting profession has struggled to maintain and improve its credibility and
image. One of the most important aspects of improving the profession’s credibility is emphasizing
ethical decision making and professional ethics in accounting education (Copeland 2005; Gaa and
Thorne 2004). With the increasing emphasis on IFRS and a principles-based approach to financial
reporting, ethical issues will become an even more important part of the accounting profession
(Verschoor 2010).
Consistent with the growing importance of ethics in accounting education, the secondary
objective of this case is to encourage students to consider the ethical issues involved in creating the
financial statements. This objective is accomplished by introducing students to an argument
between the CEO and CFO and the controller regarding how the adjustments already discussed
should be reported in the financial statements. As part of this argument, students are introduced to
typical pressures to manipulate earnings, commit fraud, and hide information from auditors and
investors. They are also introduced to an accounting adjustment that can be used to offset or hide
the negative net income or EPS effects of other entries. Students are then required to discuss the
pros and cons of each side of this argument, and to discuss what they feel the solution will be and
what the solution should be.
In addition to the two principal objectives, the case also provides an opportunity for students to
complete the adjusting entries and revised financial statements using IFRS, rather than U.S. GAAP.
Although the body of the case is written from a U.S. GAAP perspective, students can complete the
case requirements using IFRS. While the fundamental adjusting entries required are similar under
the two standards, the account titles and some of the calculations are different. More importantly,
students can make their final adjustments to a set of IFRS-style financial statements, which are very
different from U.S. GAAP statements. Appendix A contains a set of Frosty’s original financial
statements following IFRS conventions, rather than U.S. GAAP. The case solution addresses both
U.S. GAAP and IFRS.
One additional aspect of the case that has caught the attention of recruiters and other
practitioners is the introduction of basic tax consequences. For each of the four adjusting entries,
students are required to make any necessary adjustments for income taxes. Because this case is
intended for students that typically have not yet taken any tax courses, the tax implications are
simple (all changes are made to the income tax expense and income taxes payable accounts;
deferred taxes are not considered). However, the tax professionals I have talked with encourage the
inclusion of some tax effects when considering accounting transactions. Too often, they claim,
taxes are simply ignored in financial accounting classes. Even with the simplifications, students still
get a feel for the constant effect of taxes on accounting decisions.
Intended Course and Audience
The case has been used successfully with undergraduate students in the first half of a twocourse series in intermediate financial accounting. The case is intended to be used at either the end
of such a course or throughout the semester. It is likely that the case could also be successfully used
at the beginning of the second course in a two-course intermediate series, or of the final course in a
three-course series as a review of the material covered in the previous course or courses. The ethical
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discussion portion of the case could also be used in upper-division accounting or auditing courses.2
The IFRS version of the case has also been successfully used in the first half of a two-course series
in intermediate accounting. This version could also be used in an undergraduate or graduate IFRS
course to give students experience working with IFRS transactions and financial statements.
Assigning the Case
I use this case as a final project, so it does not take the place of traditional homework. By the
time students begin working on this project, I expect them to already be familiar with the four basic
adjustments required because of the homework and in-class examples they have already completed.
Because of the amount of work involved in the case, I have primarily assigned the first seven
questions to small groups. Groups of three seem to be ideal, since larger groups tend to break up the
work in a way that prevents many of the students from having the opportunity to work with all of
the elements in the project, and since partnerships tend to have difficulty with the amount of work
required. The final question (the ethics portion), I assign to each student individually. After several
semesters of randomly assigning groups, I now allow the students to form their own groups, with
some help from me if they cannot find enough members or if their group becomes too large.
Allowing students to form their own groups has greatly reduced the ‘‘whining’’ about unfair
assignments and appears to reduce shirking. I believe this last effect is due to peer pressure, since
students typically choose to work with their friends. I typically require students to send me the
names of their group members within the first three or four weeks of the semester. This step ensures
that the groups are formed and ready to go at least a week before we cover the first of the four
adjustments in class.
Students typically spend between six and ten hours working on the project with their group,
and five to six hours working on the project on their own (completing assignments for their group
and answering the ethics question).3 In the first course of a two-course intermediate series, I
typically make the case available at the beginning of the semester. This encourages students to at
least think about the case throughout the 16-week semester, and provides opportunities to talk about
the case each time we cover one of the adjustments being considered. Since these courses consist
primarily of junior-level students, I take several opportunities throughout the semester to encourage
them to begin working on the case instead of waiting until the last minute. Anecdotal evidence from
my conversations with students suggests that they typically ignore my recommendations and work
on the case during the week before it is due. However, setting up the groups early and mentioning
the requirements as we go reduces students’ ability to shift blame to me when they are stressed at
the end of the semester.
In another effort to reduce procrastination, I typically have the two parts of the case due on
different days. For example, the group portion of the case will be due the week before the semester
ends, and the individual ethics portion at the beginning of our last class session. While I have no
direct evidence that this format discourages procrastination, student feedback suggests that they
appreciate completing the majority of this case early because it allows them to focus on other
classes and projects during the last week of the semester.
2
3
The case has also been used in a graduate auditing course as an example of the Sarbanes-Oxley Act (SOX) (U.S.
House of Representatives 2002) requirement that CEOs and CFOs verify the accuracy of their company’s
financial statements. Students were asked to determine the implications of SOX Section 302 for the CEO and
CFO of Frosty Co. Of 16 Master’s of Accountancy students surveyed after using the case in this way, 94 percent
agreed that the case was helpful, especially in helping them consider the ethical situations that they might face
and the pressures to act unethically. Similarly, 75 percent agreed that the case helped them to understand the
implications of SOX Section 302.
These estimates are based on students’ responses to a survey about the case.
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Helping Students Complete the Case
The most challenging aspect of the case and, therefore, the most time-consuming for students,
is adjusting the financial statements. While this is an important skill for students to learn, it is not
typically included in intermediate accounting.4 Since students have little or no experience making
these adjustments, I talk about the financial statement implications of several of the examples
presented in class. I also provide them with a series of short problems throughout the semester
requiring them to make adjustments to the financial statements for one transaction at a time. These
discussions and short examples provide students with a better feel for how the adjustments in this
case need to be made.
In order to encourage students to seek help with the case, especially the financial statement
adjustments, I do not typically provide check figures in class. I have found that some of the best
teaching moments associated with this case occur when a group brings their work to my office for a
quick consultation. These discussions allow me to tailor my explanations for each group, focusing
on those areas where they are weak and emphasizing those skills that they need to work on. For
some students, these short sessions at the end of the semester will clear up confusions they have had
since introductory accounting. Providing specific explanations to groups or individuals allows me
to give students a push in the right direction without giving away answers, although I will confirm
when an answer is correct. The format of these discussions also requires the students to attempt the
problem before they seek help. Because of the time needed to visit with and teach each group or
individual, I typically spend most of a day meeting with students.5
As part of these discussions, special care is often required to demonstrate to students how a
non-cash correcting entry affects the statement of cash flows. If the effect of changing net income
on the statement of cash flows is not discussed explicitly, most students will not make the necessary
adjustments. On the other hand, allowing students to struggle with this concept on their own can be
an excellent method of differentiating between those who have learned a few basic techniques and
those who understand the underlying principles that determine financial reporting.
Using the Ethics Portion of the Case
I typically have my students complete two ethics cases during the semester. The first case
allows me to introduce the topic of ethics and to set the stage for our later discussion of ethics
concerning Frosty Co. During the first two weeks of class, I assign the students a case from Ethical
Obligations and Decision-Making in Accounting (Mintz and Morris 2008), and have them complete
a series of questions that walk them through the ethics rubric designed by my department (see
Appendix B). The rubric was designed to follow a basic decision-making model, focusing students’
attention on the alternatives available in ethics situations and on the consequences of those
alternatives. Our departmental goals with this rubric are to make our ethics discussions consistent
throughout the department, and to encourage students to consider the consequences of their actions
before making an ethics decision. In addition to completing the case questions on this first
assignment, students also submit a personal ethical code. This part of the assignment allows
students to think about how they want to react in ethics situations before they face difficult
4
5
Some intermediate textbooks briefly introduce these concepts when the accounting cycle is reviewed. For
example, Kieso et al. (2012, 112, Illustration 3-34) demonstrates how account balances from the Adjusting Trial
Balance become part of the Income Statement.
This method of helping students does take a significant amount of time outside of class. I typically provide
between 30 and 60 minutes of help to each group or individual that comes to my office. Overall, about half of the
class will never stop by for help, either because they do not feel they need it or because they wait too long to seek
help and miss my office hours. In a course of approximately 60 students, I typically have about 20 groups and
spend between six and eight hours visiting with students about the case.
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decisions in the work force. Students are invited to adapt professional ethics codes from the AICPA,
the Institute of Management Accountants, etc., but most choose to create their own codes of
behavior.
After students have completed the first ethics case and their personal ethical code, we spend
between 30 and 40 minutes discussing the case in class. The first part of this discussion, roughly ten
to 12 minutes, is conducted in small discussion groups of three to five students that were randomly
created on the first day of class. After providing the students with time to discuss the case with their
group, I lead a discussion with the whole class. Student answers to this first case are typically rather
shallow, so our in-class discussion allows me to broaden their perspective by introducing several
alternative courses of action and many consequences that they have not yet considered. As with the
assigned questions, this discussion walks the students step by step through the model introduced in
the ethics rubric. We also discuss the importance of a personal ethical code and setting a standard
for themselves before they face the difficult decisions common in the business world.
With this background early in the semester, students are typically more comfortable addressing
the ethics issues introduced in Frosty Co. As mentioned previously, students complete this section
of the case individually after completing the rest of the case questions with their group. Having
students complete this portion individually serves two purposes. First, it forces students to think
more carefully about the ethics situation at Frosty Co. and creates a broader base of opinion for our
in-class discussion. Second, the grading of the original ethics case at the beginning of the semester
and the ethics portion of the Frosty Co. case provides a strong assessment of learning for
accreditation and development purposes.
On the last day of class, we spend the final 20–30 minutes discussing Frosty Co. as a class.
This discussion focuses on the ethics portion of the case. As a first step, I break the class into groups
of four or five students, and assign two students to take the part of the CEO/CFO while the others
take the part of the controller. I then give each group time to argue about each adjustment and how
it should be handled. I also ask the groups to discuss the pressure Simon, the controller, is under to
give in to the CEO’s demands, what they think he will choose to do, and what they think he should
do. After approximately 15 minutes, I then lead a discussion about these issues with the entire class
for the remainder of the time. During this discussion, my focus is again on the alternatives open to
Simon and the rest of the management team, their incentives, and the consequences of each
alternative. The final part of the discussion is on the difference between what the students think
should happen and what they believe will happen. This final portion of the discussion is typically
the most enthusiastic as students argue about what Simon will actually do. After our class
discussion, I typically spend the last few minutes discussing the importance of ethics in accounting
and in our personal lives.
Using the IFRS Version of the Case
One of the most difficult issues I deal with in my intermediate course is integrating IFRS into
an already-full curriculum. From my discussions with other intermediate instructors, it appears that
I am not alone in fighting with this issue. Based on feedback from our advisory board and
discussions with many recruiters, my department has chosen to integrate IFRS into our existing
curricula instead of creating a separate class. For our intermediate series, this means that we
primarily discuss U.S. GAAP, with asides to talk about the different treatments under IFRS. For
example, when discussing capitalizing interest, I walk through the U.S. GAAP rules and do an
example with the class, then discuss the IFRS rules and redo the original example with the class so
that they can see the differences between the two methods. I use homework questions, quiz
questions, and test questions to help students practice the differences that we have discussed.
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After several semesters of using the Frosty Co. case as a final project, I realized that it could
also provide opportunities for my students to work with IFRS. I created an alternative set of IFRS
financial statements and a set of instructions requiring students to do the full case using IFRS
instead of U.S. GAAP. To prepare students for this alternative version, I discuss in class both the
U.S. and IFRS treatment of all four of the issues covered in the case. Even with these discussions,
students typically require more help when completing the case using IFRS than when using U.S.
GAAP. This is especially true when they are working with the financial statements, since my
students often do not understand the format of the IFRS financial statements well enough to make
the adjustments without additional guidance. Since class time is limited, I again provide most of this
help during my office hours. The opportunity to work with students in small groups on IFRS topics
benefits student learning and my teaching, since I am able to observe firsthand the topics that need
additional clarification.
Overall, this version of the project seems to help the students, with 74 percent (of 124 students)
agreeing that the case gave them a better understanding of the differences between U.S. GAAP and
IFRS, and 78 percent agreeing that the case was good practice of IFRS methods. Anecdotally, my
experience working with the students suggests that they are more confident with IFRS after
completing the project and feel more comfortable with IFRS financial statements. Their comments
and questions during our class discussion and in my office certainly suggest that they feel more
comfortable using IFRS after completing the case.
Because of the amount of work already required in an intermediate course, I have not asked my
students to work the project, or even part of the project, using both IFRS and U.S. GAAP.
However, this could be done with a few simple modifications. One option would be to randomly
assign half of the groups in the class to complete the project using IFRS while the other half
completed the project using U.S. GAAP. This could lead to an interesting discussion, as the groups
compare the effects of the different transactions under IFRS and U.S. GAAP and discuss the
challenges with adjusting the financial statements under the two methods.6
Another option for using the case to compare U.S. GAAP to IFRS would be to ask students to
make each adjustment under U.S. GAAP and IFRS, then ask them to explain which method more
accurately captures Frosty Co.’s financial position. Alternatively, students could be asked which
methods they would pick if they were Simon and which they would pick if they were the CEO or
CFO, and why or how the arguments for and against making the adjustments would be different
under IFRS. Because of the time constraints in most intermediate courses, however, these direct
comparisons of U.S. GAAP and IFRS would probably be more appropriate in a dedicated IFRS
course or in a graduate course with greater flexibility. In an already-packed intermediate curriculum,
I believe the case is best used to practice either U.S. GAAP or IFRS, not both.
Grading the Case
I typically allocate a total of 300 points to the case, roughly 8 percent of students’ total grade.
By comparison, the course exams make up approximately 55 percent of the students’ grades. The
rest of the points are allocated to other projects (22 percent), traditional homework (5 percent), and
quizzes (10 percent). This allocation makes the case a sufficiently high portion of the grade that
students take it seriously, while not causing undue stress at the end of the semester. I have tried
making the case a higher percentage of the total points possible, but with so much group work on
the project, doing so makes it more difficult to differentiate individual performance and assign final
grades.
6
I am grateful to the associate editor for suggesting this method of using the case.
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Of the 300 points possible, I allocate 50 points to the ethics portion of the case. Students’ work
on the ethics portion is graded using the ethics rubric presented in Appendix B. Using this rubric
focuses the grading on students’ thought processes rather than on their specific answers to each
question. As juniors, I expect my students to have an average score of four points in each of the
rubric categories, for a raw score of 20 points possible. Students’ final score is then double their
score on the rubric, plus ten points for following the formatting instructions. This slightly
cumbersome way of assigning the ethics grade is a result of our department’s choice for all
instructors to use the same ethics rubric, and the need to have the ethics portion of the case be worth
a high enough percentage of the total points possible that the students take it seriously.
The other 250 points are allocated among the other seven questions. Appendix C provides a
detailed rubric for grading these seven questions. The most difficult part of the project to grade is
Question 6, where students adjust Frosty’s financial statements, since these adjustments depend not
only on the students’ calculations, but also on their decisions in Question 5 regarding which
adjustments should be made. In order to help grade this question, I use an Excel template that
automatically updates the financial statements based on each group’s earlier answers.7 This method
allows me to give students credit for appropriately adjusting the financial statements even when
they did not make the correct adjusting entries. The template also updates the ratio calculations for
Question 7.
One additional consideration in using this case over several semesters is plagiarism.
Unfortunately, there is no way to completely eliminate the possibility of students cheating on a
project of this size. However, I have done three things to help reduce the likelihood of cheating.
First, alternating between U.S. GAAP and IFRS each semester helps to reduce cheating by making
it obvious when students try to use work from the prior semester. Second, using an Excel template
in the grading process allows me to check for cheating on the project, since students who correctly
adjusted the financial statements when they made incorrect entries probably received help from
someone. Third, I do not return the projects to the students after they have been graded. Students
receive a copy of the grading rubric, as shown in Appendix C, with a few comments, but they do
not receive a marked copy of their work.8 Similarly, I do not release the solutions to the project.
None of these solutions are sufficient to eliminate cheating, but I believe they have helped to reduce
plagiarism overall.
The final factor in students’ grades on the case is a team evaluation. After completing the
project, each student submits a written evaluation of each group member, including him or herself.
The evaluation is intentionally simple: each student assigns each group member a score between
50–100 percent based on his or her contribution to completing the project. I typically also allow
the students to give extra points (up to 105 percent) for those group members that took on
additional work to make the project a success. In order to reduce the chances that students will
‘‘manage’’ their grades through this process, I require each student to provide a short description of
how each group member earned his or her score. In addition, I warn students that attempting to
give everyone more than 100 percent on the evaluation will force me to throw out their evaluation,
giving them a self-evaluation of ‘‘0’’ percent. I then weight the average evaluation each student
receives from his or her group as 10 percent of his or her group score on the project (the 250 points
that are not from the ethics portion). An example of a group evaluation form is provided in
Appendix D.
7
8
Copies of this template for both U.S. GAAP and IFRS are available from the author upon request.
Providing students with a detailed rubric has also eliminated many of the arguments I previously received from
students who received a low grade on the project.
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Classroom Validation
I have successfully used this case at the conclusion of the first section of a two-part
intermediate series, as has another instructor at a different university.9 The other instructor
commented that the case was ‘‘great’’ and that ‘‘in the one-on-one time I spent with various groups, I
saw several ‘Aha!’ moments.’’ She also indicated that she would continue to use the case in the
future. The class sizes using the case ranged from 20 students to approximately 60 students, with
more students in the spring semester and fewer in the summer and fall.
Overall, student feedback to the case was positive. During the Fall 2007, Spring 2008, Fall
2008, and Fall 2010 semesters, students completed the case using U.S. GAAP. During the Spring
2009, Summer 2009, and Spring 2011 semesters, students completed the case using IFRS. After
completing the case, students participated in an online questionnaire regarding the case and its
usefulness. Among other things, students were asked to evaluate the effectiveness of the case in
improving their conceptual knowledge of the issues raised in the case, their ability to make the
necessary adjustments to the financial statements, and their perception of the ethical issues they
might face in business. Table 6 provides the percentage of student responses related to their selfassessment of the value of the case for those students using U.S. GAAP. Table 7 provides the data
for students using IFRS.
The survey results suggest that students found the case to be useful not only in reviewing
specific journal entries, but also in understanding how journal entries affect the financial statements.
Overall, 92 percent of the students completing the case using U.S. GAAP agreed that the case
increased their understanding of how individual transactions affect the financial statements. The
overall percentage was lower for students using IFRS, but the majority (81 percent) still felt that the
case was useful in helping them learn this important skill. Similar results are seen for understanding
how to make correcting entries, usefulness of the case in introducing students to ethical situations
they might face in the future, and overall usefulness of the case. The lower percentages reported by
the students completing the case under IFRS are likely due to the difficulty U.S. students have using
IFRS instead of U.S. GAAP. Because of the amount of material that must be covered in an
intermediate course, it is difficult to give equal time to both U.S. GAAP and IFRS. Thus, many
students have a difficult time applying IFRS principles for the first time. Despite these differences,
the results from both tables suggest that the case is helpful to students. In addition, 74 percent of
students using the IFRS version of the case reported that the case helped them to better understand
the differences between U.S. GAAP and IFRS, and 78 percent reported that the case was a good
opportunity to practice IFRS methods (see Table 7).
As an instructor, I have also observed significant improvements in my students’ performance
since introducing the Frosty Co. case. One of my great frustrations before introducing this case was
students’ inability to determine the effects of various journal entries on the financial statements.
After implementing this case and the preparatory assignments, students appeared more confident in
answering test questions requiring them to adjust the financial statements.10 Perhaps more
importantly, I have also observed an increase in student confidence when working with or
discussing the financial statements, and improved critical thinking regarding transactions and the
effects of those transactions on investor perceptions. These observations are consistent with the
9
10
The other instructor used the case during the Spring 2008 semester, using U.S. GAAP. The survey results from
her students are qualitatively similar to those from other semesters, and are included with the other survey results
from students completing the case using U.S. GAAP presented in Table 6.
Unfortunately, the use of this case was only one of a number of changes that I made to my course at that time.
These changes included a different style of homework, a change in the quiz format, the addition of several
projects and cases (including this one), and a change in exam format. Because so many changes were made at the
same time, I am unable to empirically determine the effect of this case on student performance.
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TABLE 6
Summary of Student Feedback after Completing the Case Using U.S. GAAP
Question
Overall, the case increased my understanding
of how to make correcting entries.
Overall, the case increased my understanding
of how individual transactions affect the
financial statements.a
The discussion in the case and the question
on ethics helped me think about what
types of situations I might face and how I
will deal with them.
Overall, I felt the case was helpful.
Strongly
Agree
Agree
Neither Agree
nor Disagree
Disagree
Strongly
Disagree
33%
53%
10%
3%
1%
38%
54%
5%
3%
0%
34%
52%
8%
3%
2%
30%
57%
9%
4%
0%
a
Originally, this question read ‘‘Overall, the case increased my understanding of how individual transactions affect each
of the major financial statements.’’
This table presents the results from surveys given over several semesters. Approximately 55 students completed the
survey in Fall 2007, 91 students in Spring 2008, 41 students in Fall 2008, and 24 students in Fall 2010.
TABLE 7
Summary of Student Feedback after Completing the Case Using IFRS
Question
Overall, the case increased my understanding
of how to make correcting entries.
Overall, the case increased my understanding
of how individual transactions affect the
financial statements.a
The discussion in the case and the question
on ethics helped me think about what
types of situations I might face and how I
will deal with them.
Overall, I felt the case was helpful.
Overall, the case helped me to gain a better
understanding of the differences between
IFRS and U.S. GAAP.
Overall, the case provided a good
opportunity to practice IFRS accounting
methods.
Strongly
Agree
Agree
Neither Agree
nor Disagree
Disagree
Strongly
Disagree
18%
62%
18%
2%
1%
24%
57%
16%
2%
1%
31%
47%
15%
5%
2%
25%
27%
58%
48%
13%
19%
3%
4%
1%
3%
31%
47%
16%
5%
1%
a
Originally, this question read ‘‘Overall, the case increased my understanding of how individual transactions affect each
of the major financial statements.’’
This table presents the results from surveys given over three semesters. Approximately 53 students completed the survey
in Spring 2009, 21 students in Summer 2009, and 50 students in Spring 2011.
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primary objective of the case. I observed similar improvements in students’ discussion of ethics
after completing the case. This is consistent with the survey results that 86 percent of students (78
percent for those completing the IFRS version of the case) agreed that the case helped them
understand the ethics issues they would face in business.
When students use IFRS instead of U.S. GAAP to complete the case, these improvements are
even more noticeable. Before completing the case, my students work only a few in-class IFRS
examples. Working with specific entries and actual IFRS financial statements in a case format
appears to greatly improve their understanding of IFRS. While they often express frustration with
not knowing more about IFRS while doing the project, their confidence in addressing IFRS topics
appears to be much stronger after completing the case.
Limitations of the Case
While I believe that the case provides students with opportunities to practice critical thinking
and consider ethical issues in accounting, there are several limitations in adapting and using the
case. Perhaps the most significant limitation is the amount of time required to fully implement the
case. The most obvious time commitment is the amount of time required outside of class, especially
when using the IFRS version of the case. As mentioned previously, I spend approximately five to
eight hours working with my students outside of class on the case. In addition to the time spent
helping students complete the case, a significant amount of time is also needed to effectively grade
the case. This time commitment comes primarily from allowing students to determine which
adjustments need to be made to the financial statements, then determining if the students have
correctly made those adjustments. While I use grading templates to speed up the process, I still
spend between six and eight hours grading the case each semester, depending on the number of
submissions. The ethics portion of the submission requires an additional eight to ten hours, again
depending on the number of submissions. The familiarity of the grader, and his or her familiarity
with the ethics rubric being used, can also greatly affect the amount of time needed to grade the
project. For schools with increasing teaching loads or class sizes, this significant time commitment
might make it difficult to implement the case.
The second limitation of the case is the student time commitment to fully complete the
requirements. My students spend a significant amount of time working on this case (between 11 and
16 hours, as mentioned previously). In an intermediate curriculum that already includes homework,
quizzes, exams, and other projects, it can be difficult for students to complete such a timeconsuming project.
The third limitation of the case applies because the case was originally written to be used with
U.S. GAAP, not with IFRS. While the case questions and methods apply to either standard, the
language in the case is consistent with U.S. GAAP instead of IFRS. Because of the language in the
body of the case, students often have difficulty making the transition from U.S. GAAP terminology
in the reading to IFRS in their work. This limitation can be mitigated by providing students only
with the IFRS financial statements and by discussing the importance of IFRS in their careers when
assigning the case. However, even after these efforts, some students will still use U.S. GAAP
account titles and methods when answering the first four questions, and a few will be frustrated at
having to complete an IFRS project.
CONCLUSION
This case has two primary learning objectives: to help students practice critical thinking skills
in accounting, and to encourage students to consider the ethics issues involved in creating the
financial statements. The first objective is accomplished primarily by requiring students to adjust a
set of financial statements for a set of correcting entries. Students also practice these skills by
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determining what corrections are needed for the four potential problems identified in the case, by
considering simple tax implications for each correction, and by considering likely investor reaction
to the changes. The second objective is accomplished by considering the differing viewpoints of the
CEO and CFO and the controller, and determining how the ethics issues should be resolved. In
addition to these main objectives, the case can also help students practice IFRS methods and rules
or form the basis for a comparison between the two methods.
TEACHING NOTES
Teaching Notes are available only to full-member subscribers to Issues in Accounting
Education through the American Accounting Association’s electronic publications system at http://
aaapubs.org/. Full-member subscribers should use their usernames and passwords for entry into the
system where the Teaching Notes can be reviewed and printed. Please do not make the Teaching
Notes available to students or post them on websites.
If you are a full member of AAA with a subscription to Issues in Accounting Education and
have any trouble accessing this material, then please contact the AAA headquarters office at info@
aaahq.org or (941) 921-7747.
REFERENCES
Accounting Education Change Commission (AECC). 1990. Objectives of education for accountants:
Position statement number one. Issues in Accounting Education 5 (2): 307–312.
Albrecht, W. S., and R. J. Sack. 2000. Accounting Education: Charting the Course through a Perilous
Future. Vol. 16. Sarasota, FL: American Accounting Association.
American Institute of Certified Public Accountants (AICPA). 1999. Core Competency Framework. New
York, NY: AICPA.
Camp, J. M., and A. L. Schnader. 2010. Using debate to enhance critical thinking in the accounting
classroom: The Sarbanes-Oxley Act and U.S. tax policy. Issues in Accounting Education 25 (4):
655–675.
Copeland, J. J. E. 2005. Ethics as an imperative. Accounting Horizons 19 (1): 35–43.
Crumbley, D. L., K. T. Smith, and L. Murphy Smith. 1998. Educational novels and student role-playing: A
teaching note. Accounting Education 7 (2): 183–191.
Gaa, J. C., and L. Thorne. 2004. An introduction to the special issue on professionalism and ethics in
accounting education. Issues in Accounting Education 19 (1): 1–6.
Jenkins, E. K. 1998. The significant role of critical thinking in predicting auditing students’ performance.
Journal of Education for Business 73 (5): 274–279.
Kealey, B. T., J. Holland, and M. Watson. 2005. Preliminary evidence on the association between critical
thinking and performance in principles of accounting. Issues in Accounting Education 20 (1): 33–49.
Kieso, D. E., J. J. Weygandt, and T. D. Warfield. 2012. Intermediate Accounting. 14th Edition. Hoboken,
NJ: John Wiley and Sons.
Mintz, S. M., and R. E. Morris. 2008. Ethical Obligations and Decision-Making in Accounting: Text and
Cases. New York, NY: McGraw-Hill/Irwin.
Senatra, P. T. 1983. The statement of changes in financial position: A flow-chart approach to teaching
concepts and procedures. Issues in Accounting Education 1: 95–103.
Smith, G. F. 2003. Beyond critical thinking and decision making: Teaching business students how to think.
Journal of Management Education 27 (1): 24–51.
Springer, C. W., and A. F. Borthick. 2004. Business simulation to stage critical thinking in introductory
accounting: Rationale, design, and implementation. Issues in Accounting Education 19 (3): 277–303.
Springer, C. W., and A. F. Borthick. 2007. Improving performance in accounting: evidence for insisting on
cognitive conflict tasks. Issues in Accounting Education 22 (1): 1–19.
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How Adjusting Entries Affect the Quality of Financial Reporting: The Case of Frosty Co.
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U.S. House of Representatives. 2002. The Sarbanes-Oxley Act of 2002. Public Law 107-204 [H. R. 3763].
Washington, D.C.: Government Printing Office.
Verschoor, C. C. 2010. IFRS would escalate ethical challenges for accountants. Strategic Finance 92 (1):
13–18.
Zeff, S. A. 2003. How the U.S. accounting profession got where it is today: Part I. Accounting Horizons 17
(3): 189–205.
APPENDIX A
Frosty Co. Financial Statements using IFRS
IFRS Income Statement
Frosty Co.
Statement of Profit or Loss
For the Year Ended December 31, Year 2
Revenue
Sales Revenue
Less: Sales Discounts
Sales Returns and Allowances
$4,452,300
($44,523)
($25,000)
Net Sales Revenue
Cost of Goods Sold
Inventory, Dec. 31, Year 1
Purchases
Less: Purchase Discounts
Purchase Returns
Purchase Allowances
Net Purchases
Freight In
($69,523)
$4,382,777
($495,600)
($1,850,000)
$37,000
$92,500
$18,500
($1,702,000)
($61,500)
Cost of Merchandise Available for Sale
Inventory, Dec. 31
Less: Year 2
($1,763,500)
($2,259,100)
$775,000
Cost of Goods Sold
($1,484,100)
Gross Profit
$2,898,677
Other Income
Rent Revenue
Administrative Expenses
Depreciation Expense
Insurance Expense
Supplies Expense
Utilities Expense
($782,500)
($92,000)
($52,450)
($97,800)
($1,024,750)
Selling Expenses
Advertising Expense
Bad Debt Expense
Warranty Expense
($445,230)
($62,000)
($39,950)
($547,180)
$70,000
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APPENDIX A (continued)
Frosty Co.
Statement of Profit or Loss
For the Year Ended December 31, Year 2
Other Expenses
Miscellaneous Expense
Wages Expense
Loss on Sale of Machinery
($97,205)
($355,000)
($67,500)
($519,705)
Results from Operating Activities
Finance Expense
($2,021,635)
$877,042
($87,174)
Profit before Taxation
Income Tax Expense (30%)
$789,868
($236,960)
Profit for the Period
$552,908
EPS
Basic Earnings per share (250,000 shares outstanding)
$2.21
IFRS Balance Sheet
Frosty Co.
Statement of Financial Position
As of December 31, Year 1 and December 31, Year 2
Year 2
Year 1
Assets
Land
Building
Equipment
(Accum Depr)
Intangible Assets
$1,250,000
$8,870,000
$11,000,000
($7,582,500)
$3,250,000
$1,250,000
$7,500,000
$10,500,000
($6,800,000)
$3,250,000
Total Non-Current Assets
Inventory
Trade and Other Receivables
(Provision for Bad Debts)
Prepayments for Current Assets
Cash
$16,787,500
$775,000
$600,000
($72,000)
$115,000
$95,050
$15,700,000
$495,600
$350,000
($40,000)
$150,000
$85,000
Total Current Assets
$1,513,050
$1,040,600
$18,300,550
$16,740,600
$125,000
$5,093,300
$9,661,508
$50,000
$4,989,000
$9,208,600
$14,879,808
$0
$14,247,600
$0
Total Assets
Equity
Share Capital
Share Premiuma
Retained Earnings
Total Equity attributable to equity holders of Frosty
Minority Interest
Total Equity
$14,879,808
$14,247,600
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APPENDIX A (continued)
Frosty Co.
Statement of Financial Position
As of December 31, Year 1 and December 31, Year 2
Year 2
Year 1
Liabilities
Loans Payable
Bonds Payable
$1,650,000
$678,500
$650,000
$678,500
Total Non-Current Liabilities
Bank Overdraft
Trade and Other Payablesb
Interest Payable
Current Tax Payable
$2,328,500
$10,000
$835,852
$60,000
$186,390
$1,328,500
$10,000
$1,057,000
$40,000
$57,500
Total Current Liabilities
$1,092,242
$1,164,500
Total Liabilities
$3,420,742
$2,493,000
$18,300,550
$16,740,600
Total Equity and Liabilities
a
Includes 1,000 treasury shares purchased for $11/share.
Consists of the following accounts:
Accounts Payable: $433,659 in Year 2, $750,000 in Year 1.
Other Payables: $77,193 in Year 2, $52,000 in Year 1.
Unearned Sales Revenue: $325,000 in Year 2, $255,000 in Year 1.
b
IFRS Statement of Cash Flows
Frosty Co.
Statement of Cash Flows
For the Year Ended December 31, Year 2
Cash Flows from Operating Activities
Profit before Taxation
Adjustments for:
Depreciation
Loss on Sale of Machinery
Finance Charge
Increase in Trade and other Receivables
Increase in Inventory
Increase in Interest Payable
Decrease in Prepayment for Assets
Decrease in Trade and Other Payables
Cash Generated from Operations
Interest Paid
Income Taxes Paid
Net Cash Flows from Operating Activities
$789,868
$782,500
$67,500
$87,174
$1,727,042
($218,000)
($279,400)
$20,000
$35,000
($221,148)
$1,063,494
($137,174)
($108,070)
$818,250
(continued on next page)
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APPENDIX A (continued)
Frosty Co.
Statement of Cash Flows
For the Year Ended December 31, Year 2
Cash Flows from Investing Activities
Proceeds from Sale of Equipment
Purchase of PPE
Construction of Building
Net Cash Flows Used in Investing Activities
Cash Flows from Financing Activities
Proceeds from Issue of Share Capital
Proceeds for Long-Term Borrowings
Dividends Paid
Net Cash Flows Provided by Financial Activities
Net Increase in Cash and Cash Equivalents
Cash and Cash Equivalents at Beginning of Period
Cash and Cash Equivalents at End of Period
$477,500
($1,065,000)
($1,300,000)
($1,887,500)
$179,300
$1,000,000
($100,000)
$1,079,300
$10,050
$85,000
$95,050
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APPENDIX B
Ethics Rubric
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APPENDIX C
Example Grading Rubric
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APPENDIX D
Example Group Evaluation Form
Acct 315 Comprehensive Project
Team Evaluation
As described in the syllabus, your final grade on the Comprehensive Project will be a
composite of the grade that your team earned, the grade on the individual ethics portion, and the
grade your team assigns to you for your participation. This is your opportunity to reward members
of the team that did more than their share and to report anyone that ‘‘shirked.’’ Please be honest and
fair in evaluating your teammates, as you hope they will be when they evaluate you.
Here’s how it works. You will give each team member, including yourself, a grade from 50–
100 percent. Keep in mind that a good job is a 100 percent, a decent job is a 90 percent, and a poor
job is an 80 percent or less. You should use 100 percent as a baseline. Then, if you feel that anyone
did more of the work, you should raise his or her grade. If you felt a team member did not do his or
her fair share, you should assign that person a lower grade.
I will take the average percentage and weight it in as 10 percent of your final grade on the
project. So, if your total score on the team portion of the Comprehensive Project was 100 points and
the average score from this evaluation was 80 percent, you would end up with 98 points: (100 90
percent) þ (100 80 percent 10 percent).
Please be fair in assigning these grades. I am not giving you the chance to ‘‘manage’’ your
grades or to get even; I just want to give you the opportunity to let me know if someone did more
(or less) than the fair amount of work. By the way, if you give everyone more than 100 percent, I
will throw out your scores. If you do not turn in this form or if I throw out your scores, I will give
you a 0 percent for your evaluation of yourself (which will seriously drop your evaluation average).
You should explain your grade for each person. If you need additional room for your
explanation, please put it on the back of this page.
This form is due on the same day as the individual portion of the Comprehensive Project.
To aid in the grading process, please list the members of your group (including yourself ) in
alphabetical order by last name:
Evaluator’s Name:
Group Member Name
Score
Reason (see above)
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