Case 08-10
Chocolate Rocks: Accounting Errors
Bedrock Quarry Company
Part A
Bedrock Quarry Company (“Bedrock”) is an SEC registrant with a December 31, 20X9,
fiscal year end. This is the first year that Bedrock is an SEC registrant. Green Dot is
Bedrock’s auditor. Materiality for the audit is expected to be $20,000.
On October 10, 20X9, Fred, the CFO of Bedrock, is meeting with Barney, the audit
partner, to review the preliminary results of the third quarter interim review. Barney
presents Fred with a copy of the draft unadjusted error summary, which contains one
error.
During the year, Bedrock did not capitalize individual expenditures of less than $2,500,
which is in accordance with its company policy. Historically, because Bedrock’s capital
expenditures have been relatively constant each period, the policy has not caused any
material errors. However, Bedrock undertook a significant plant expansion by opening
another quarry and rock finishing plant in fiscal year 20X9. As a result, Bedrock
incurred eight capital expenditures of $2,000 each in its first three quarters that were not
capitalized. The construction department expects another five capital asset purchases of
$2,000 each before year end. Therefore, a total of $26,000 of purchases would have been
expensed rather than capitalized by year end.
Bedrock is following the guidance in ASC 250-10, Accounting Changes and Error
Corrections (SEC Staff Accounting Bulletin No. 108, codified as SAB Topic 1.N,
“Considering the Effects of Prior Year Misstatements When Quantifying Misstatements
in Current Year Financial Statements” (SAB 108)), for third quarter reporting (July 1
through September 30, 20X9).
Required:
•
When Bedrock applies ASC 250-10 (SAB 108), would its capitalization policy
result in a material unadjusted error that would have to be corrected in the third
quarter financial statements (i.e., record a journal entry to reverse the expense and
record the capital asset)?
Part B
In addition to the information provided in Part A, consider the facts presented below:
In fiscal year 20X8, Bedrock understated its fixed assets by $10,000 in accordance with
its policy not to capitalize asset purchases under $2,500. Bedrock determined that this
misstatement was not material to its 20X8 financial statements. For the last two fiscal
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All Rights Reserved.
Case 08-10: Chocolate Rocks: Accounting Errors
Page 2
periods, Bedrock used the rollover method to assess whether unadjusted errors were
material. Prior to that, Bedrock had used the iron curtain method.
Iron Curtain Method — this approach quantifies the misstatement based on the amount
required to correct the misstatement in the balance sheet at the period end irrespective of
the misstatement’s year of origination.
Rollover Method — this approach quantifies the misstatement based on the amount of the
error that originates in the current year income statement. This approach ignores the
effects of correcting the portion of the current year balance sheet misstatements that
originated in prior years (i.e., it ignores the “carryover effects” of prior year
misstatements).
In response to the question above, assume it was determined that Bedrock had to record a
journal entry at the end of the third quarter to capitalize $16,000 of fixed assets, thus
reversing the expense previously recorded in the income statement.
Required:
•
When Bedrock applies ASC 250-10 (SAB 108), can it use the cumulative-effect
correction to correct its immaterial errors from prior years?
Belgian Chocolate Company
Belgian Chocolate Co. (“BCC”) is a highly leveraged company that just completed its
second year of operations on December 31, 20X9. The business has not generated
significant revenues and does not have significant net assets since it only imports and
distributes chocolate. BCC obtained its financing from two sources: (1) its IPO in early
20X8 and (2) a loan from a commercial development bank that is charging interest at
prime plus 2 percent. The five-year bank loan has a bullet maturity for both principal and
interest. BCC’s auditor performed its year-end close for 20X9 and discovered that BCC
did not record interest expense for its bank loan during its first year of operations in
20X8. The annual interest expense on the loan is $100,000. No additional errors have
been identified related to the current period or any prior periods.
The materiality for the 20X9 audit is $110,000 and the materiality for the 20X8 audit is
$75,000. BCC previously used the iron curtain method of assessing the materiality of
errors and is applying ASC 250-10 (SAB 108) for its December 31, 20X9, financial
statements.
Required:
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All Rights Reserved.
Case 08-10: Chocolate Rocks: Accounting Errors
•
Page 3
Can BCC take advantage of the cumulative-effect correction to record the 20X8
interest expense on the loan in 20X9?
Copyright 2007 Deloitte Development LLC
All Rights Reserved.