Apollo Shoes Memo
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The company’s total losses/expenses as management has estimated are $11 million. The total amount that the auditor might suggest would be about $18.6 million. This means that the materiality threshold is broken for materiality of misstatement of net income, even though as shown below, each entry itself does not break that threshold by itself. The deferred costs can be divided over the next 2 years. So this year’s entry would be as follows and there should be a disclosure note about the remaining $6,000,000. There also should be a disclosure about the uncertainty of the company. Subscription expense$6,000,000
Deferred Subscription Costs$6,000,000
To recognize and record the deferred subscription costs being expensed.
The company needs to expense the projected uncollectible debts. Bad debt expense$4,000,000
Allowance for uncollectible accounts$4,000,000
To create an allowance for uncollectible debt.
For the expected warranty expense, there is not probability given of how much it will cost. So going on the low side it could only be $2 million and on the high side it could be $6 million. This range itself would be considered immaterial because it is below the $7 million threshold. Therefore, this one should be left up to management’s decision and a disclosure note should accompany the financial statements indicating that possible range of warranty expenses, etc. Warranty Expense$2,000,000
To record the estimated warranty liability.
To mark down the loss on the inventory that is now obsolete, one first has to figure out the Net Realizable Value, which is the lower of cost of market. Since they can sell the products for $8 million minus the selling cost of 20% of the sales revenue ($1.6 million) and the cost to rebuild the inventory of $2 million, the ceiling is then $4.4 million and the floor is $4 million ($4.4 million minus the 5% normal profit ($400,000)). The NRV therefore is the $4.4 million. And since the cost to manufacture replacement parts would be $6 million, this means that the market price is $6 million. Taking the lower of cost or market makes the write off amount $10 million minus $4.4 million, or $5.6 million Cost of Goods Sold$5,600,000
To record the write-down of inventory.
Because the lawyer estimates as low as a loss of $1 million on the government contract refund they are allowed to record that loss at the lower estimate rather than what the government is claiming on the refund. Loss on Contract Refund$1,000,000
To record the estimated loss on the contract refund.