During Hydromaint's audit, you and Pam had a number of discussions. You, Pam, and Mike Johnson are generally satisfied that the accounts are in accordance with GAAP and are supported by underlying facts. Pam tested Jerry's pension accounting (which she found to be correct) by preparing a pension worksheet based on data contained in the actuary's report:

Current service cost $1,064,043

ABO at 12/31/X7 2,840,000

Interest on the PBO 8%

Interest on plan assets 8

Jerry has agreed to adjust his accounts and note disclosures for all corrections proposed by

C & L. Pam raised a number of questions that may require adjustment. No other matters were found to be questionable. Pam's questions are as follows:

1. Accounting for R&D does not appear to be in compliance with SFAS No. 2. The work is of the nature described in SFAS No. 2, para. 9, and is not being conducted for others under contract.

2. Pam also noted that warranty contracts are given on all sales of pumps and valves. LS-Pump/Valve and now Hydromaint, have accounted for warranties only on the costs to "make good" when warranty claims were actually filed by customers. If warranty costs had been recognized as sales were made, the liability at January 1, 20X7, would have been $500,000. Pam noted, however, that Nick Riley and Ray Ballard were aware of the warranty contracts and took these into account in valuing the acquisition of LS-Pump/Valve. Nick and Ray did not know, however, that a liability must be recognized as warranty sales are made. Costs incurred during 20X7 to settle warranty claims amounted to $160,000. These costs were charged to cost of goods sold. It also was estimated that warranty costs applicable to 20X7 sales amounted to $146,362. Pam found out from Linda Durkee that warranty costs are deductible for tax purposes only as make-good costs are incurred.

3. Mike Johnson determined that the value of the ending inventories under FIFO would have been higher than under LIFO, as follows:

Inventory - merchandise $140,000

Inventory - raw materials and WIP 300,000

Mike also found that income before taxes under FIFO would have been higher than under LIFO by about $440,000.

4. The accounting for income taxes will have to be revised. Pam suggests that the first entry be reversed and a new one be set up. Pam also was informed by Linda Durkee that purchased goodwill could be amortized over 15 years and was deductible for income tax purposes. Consequently, Hydromaint has elected to amortize goodwill over 15 years.

5. Pam also noted that the deal for the exchange of crew trucks fell through.

6. Finally, Jerry had provided the following segment disclosures from this year's financial reports that he now routinely prepares for Nick and Ray. As before, they use this information to make decisions about the company's operations. Additionally, any transactions and/or adjustments recorded during the year related to the operations of the newly acquired LS-Pump assets were recorded in the merchandising segment. Finally, research and development activities are considered corporate transactions.

Maintenance Merchandising Corporate Total

Customer revenue $8,540,000 12,548,117 - $21,088,117

Interest expense - - 32,566 32,566

Depreciation & amortization 66,592 59,529 - 126,121

Segment profit 1,955,157 2,184,835 (352,667) 3,787,325

Segment assets 1,276,977 7,710,177 1,746,871 10,734,025

REQUIRED:

Based on the data developed by Pam and Mike, redraft the balance sheet and the statement of income and retained earnings and prepare the statement of cash flows and the related notes. All changes must be supported by analyses and/or authoritative sources.

Bibliography

St. Joseph's University

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