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Critical Thinking Case Study Assets
It is February 1, 2014, and you are working as the senior auditor for Sanders and Wilson CPA Firm on the December 31, 2013 year-end financial statement audit of G & O Manufacturing Company (G & O, hereafter). This is the first year that you have audited the firm. G & O is a publicly traded company that manufactures radiators for 18-wheeler trucks. You have been assigned to audit the balance of G & O’s plant asset account, which represents 73 percent of the total value of G & O’s total assets. Although you have extensive auditing experience in the merchandising industry, this is your first audit of a major manufacturing company.
During the course of the audit, you notice that the total net book value of G & O’s plant assets as of December 31, 2013 is $600 million. An overview of the composition of the plant assets account is as follows:
Current Assets $ 30 million
Noncurrent Assets 570 million
Total Plant Assets $ 600 million
Prior to performing substantive tests of the plant asset account balance, you ask G & O’s controller why the net assets are classified as both current and noncurrent assets. The conversation proceeds as follows:
Auditor: Dear Controller, why have you classified a portion of your plant assets as current assets?
Controller: Well, I know that there appears to be a mistake in separating the plant assets between the current and noncurrent asset category, but this classification is within the requirements of Generally Accepted Accounting Principles (GAAP, hereafter).
Auditor: Please explain.
Controller: My pleasure. I will explain this to you in terms of the requirements for both current assets and current liabilities. Generally Accepted Accounting Principles defines current assets as cash and other assets expected to be converted to cash or consumed either in a year or in the operating cycle (whichever is longer), without disturbing the normal operations of a business. According to G & O’s accounting policies and procedures manual, the upcoming year’s estimated depreciation on plant assets is reclassified from noncurrent assets to current assets. This represents the amount of estimated depreciation that will be used up (i.e. expensed) in the upcoming year.
G & O depreciates its plant assets over 20 years (no salvage value) on a straight-line depreciation basis. As it relates to the financial statements, the current asset balance relating to plant assets ($30 million) represents 1/20th of the total net book value of the $600 million of plan assets to date.
To place G & O’s application of the current asset definition in perspective, the same concept is used in the classification of inventory as a current asset. Inventory is classified as a current asset since it is expected to be used up (i.e. expensed; consumed) during the next year, either in the manufacturing process or when the finished goods are sold. As such, inventory is expected to be expensed during the upcoming year, in the same way that a portion of the G & O’s plant assets are expected to be expensed in the upcoming year.
As relates to GAAP’s classification of current liabilities, GAAP requires companies to reclassify any portion of its noncurrent debt as current debt if the debt will be paid within the next year or the next operating cycle, whichever is longer. Therefore, it is only logical for us to reclassify a portion of G & O’s total plant assets as current assets, which mirrors the classification of a portion of the long-term liabilities as current liabilities.
As an auditor, you have little experience auditing plant asset account balances. In addition, the controller’s application of GAAP’s current asset definition to the treatment of current plant assets appears to be air tight! As you review G & O’s prior year audit work papers, you find evidence that their former Big 4 auditor did not have an issue with G & O’s accounting treatment of their plant assets. The former Big 4 auditor issued a clean audit opinion on G & O’s financial statements However, you as an auditor are to exercise professional skepticism regarding whether you will accept the controller’s position that a portion of G & O’s plant assets are to be classified as current assets.
In order to evaluate the controller’s explanation, you are to search the online Accounting Standards Codification (ASC) for authoritative support as to whether you believe or disbelieve the controller’s position. You should discuss the ASC’s standards on the treatment of Current Assets, Current Liabilities, and Plant Assets (i.e. Property, Plant, and Equipment). Your response to the controller’s position will be included in the working papers.
Your assignment is to provide a full two-page response, which is to be typed and submitted via Blackboard by the due date in Blackboard Your response should (1) identify any relevant issue(s) that you have with the controller’s treatment of the issue, and (2) you are to provide a solution to the issue(s). You will need to search the online Accounting Standards Codification (ASC) for authoritative support for the positions you are taking in your solution. Your solution should contain specific references to the ASC standard numbers upon which you rely to formulate your solution. You should cite appropriate authoritative guidance from the FASB Accounting Standards Codification.