1. Restate the financial statements in standardized format
2. Assess whether long term asserts are valued correctly
a. Consider whether the asset value has been impairment
b. Review method and amount of depreciation charged
c. Assess useful life of the asset
d. Assess salvage value of the asset
e. Review intangible assets such as intellectual property such as patents, copyrights, trademarks, brand value- how are they valued, are they value correctly
3. Review operating versus capital leases
• In cases where a business acquires a long term asset via a lease arrangement it is a capital lease when 75% or more of the asset value is used up during the lease term or 75% or more of the useful life of the asset expires during the lease term
• Capital leases are actually a purchase of the asset with financing options provided by the leasor or the seller, the asset is recorded on the balance, the long term debt is recorded as a liability, there is no regular lease expense the lease payment is recorded as a reduction in the liability
• If the terms of a capital lease are not met then it is an operating lease where there is no acquisition of the asset
• Operating leases are recorded as annual lease expense only. This reduces net income on the income statement, there is no asset recorded and no liability recorded
• The current economic value of the asset is calculated as the present value of the future lease payments
• Consider the effect of a lease being recorded as an operating lease incorrectly in a case where it actually should be a capital lease
o Expenses will be over stated
o Net income will be understated
o Long term assets are under stated
o Long term debt is understated
o This may just be an error or the business may be motivated to minimize income and therefore taxes
• Consider the effect of a lease being recorded as a capital lease incorrectly in a case where it actually should be an operating lease
o Expenses will be understated
o Net income will be overstated
o Long term assets will be overstated
o Long term debt will be over stated
o This may be an error or the business may be motivated to inflate net income, inflate assets
4. Contingent Liabilities
a. Lawsuits- see question 7 in chapter 4 discussion questions on the course site for treatment
b. Claims such as reserves in the case of an insurance company
c. Unearned revenue
d. Pension liabilities
5. Brand value incorrectly valued
6. Over statement of revenue
a. Inflated revenue
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