QuestionQuestion

Graphic Apparel Corporation Case Study
Read the following case study:
Phillips, Fred. Evaluating Financial Results at Graphic Apparel Corporation (G A C ): The Impact of Accounting Policies. American
Accounting Association
You will need to make some adjusting journal entries to correct because of issues that occurred in the case.
Questions 1-24 are designed to help you identify those journal entries
Part A (25 Points)
Prepare a brief memo to Nicki addressing her concerns. Be clear as to any changes that you believe should be made to the financial statements and why. Make sure your memo is clear and concise and in language, she can understand and indicates the step you would recommend Nicki take. In your memo, you should answer questions 1-25.
In your memo, include the next steps you would recommend for Nicki considering all of the following issues and questions:
1. What are the key changes affecting GAC this year including?
a. Explain the loan covenant. What is a loan covenant? Based upon the case, what is required with respect to the current ratio - what current ratio must she maintain?
b. What is the current ratio as reported - before any of the issues in case occur
c. Who owns GAC?
d. Who uses GAC's financial statements?
e. What is significant about GACs business relationship with its new user?
2. What are the big events to account for in 2014 and how does it affect others?
a. How is the custom shirt business working out?
b. What do we know about GAC’s customer base?
c. How is the new graphic design working out?
d. What happened at the warehouse this year?
3. What is the revenue recognition principle? At what point does GAAP indicate revenue should be recognized? Has this changed since 2014?
4. When does GAC report its revenue from custom orders? Under what circumstances would this be appropriate?
5. What alternative point in time exists for reporting revenue from custom orders?
6. What method do you think is best for recognizing revenue from custom shirts? What arguments support that method?
7. How would changing to this alternative method affect GAC’s financial statements? How would changing to this alternative method affect GAC’s current ratio?
8. At what value does GAAP require accounts receivable to be reported?
9. What method of accounting for bad debts does GAC use? When is this method okay?
10. Has anything changed this year to suggest this approach for bad debts is no longer acceptable?
What do you learn from the number of days to collect receivables in 2014 versus 2013?
11. What alternative method could GAC use for bad debts? Does any evidence suggest it is better?
12. What method of accounting for bad debts do you think GAC should use?
13. How would changing to this alternative method affect GAC’s financial statements? How would changing to this alternative method affect GAC’s current ratio?
14. When does GAC report sales returns? Under what circumstances is that method acceptable?
15. Have circumstances surrounding returns changed in 2014? How?
16. What does GAAP recommend under these new circumstances?
17. Should GAC consider this alternative? Why? Are sales returns material to the key external user?
18. Which method of accounting for sales returns do you think is best?
19. How would changing to this alternative method affect GAC’s financial statements? How would
changing to this alternative method affect GAC’s current ratio?
20. Using what measurement does GAAP require inventory to be reported?
21. Using what measurement has GAC been reporting its inventory? When is this appropriate?
22. Has anything changed this year to suggest this approach is no longer acceptable? What do you learn from the number of days to sell inventory in 2014 versus 2013?
23. Is there any evidence to suggest that GAC will have to mark down its selling price below cost? What does the gross profit percentage in 2014 indicate about the margin of difference between selling price and cost?
24. What do you think GAC should do when reporting its inventory of graphic shirts?
Part B (35 points)
1. Based upon your analysis above, list the complete Journal Entries that need to be made (include amounts.)
Part C (15 points)
Because Nicki has a loan, she must comply with the loan covenant. Based upon the case, what is required with respect to the current ratio? Determine what Nicki will need to do to ensure she complies with the loan covenant.
Go through each journal entry in Part B and explain how it impacts the current assets or current liabilities. If all the proposed journal entries above are made, how would GAC’s current ratio change?

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GAC is having several key changes happening within the organization. In this memo some concerns relevant for the company will be addressed.
Loan covenant can be identified as the conditions in a loan or a bond where the borrower is required to fulfill those requirements and conditions when taking the loan. GAC requires to have a minimum current ratio of 1.0. Currently GAC is having a current ratio of 1:1.3 (61000/45180). Currently GAC is owned by Nicki after taking over it from previous owner. Previously their financial statements were reviewed only by Internal Revenue Service (IRS). It is very significant that Nicki is the new user because she has experience in the business.
After Nicki took over the business, she is doing several changes in to it. Some of the changes are providing alteration services to customers and recording customers as trade receivables without collecting cash in advance. Custom shirts business working in an approach where the customers are paying in advance for the orders. Some of the customers of the business can be identified as retailers, local sport teams, community organizations. And Nicki is trying to offer bold and inspiring graphic...
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