1. Foxworthy, Inc. is a manufacturer with a calendar accounting year. A physical inventory is taken on January 1, and any items not in inventory are charged to cost of goods sold. The current year is 2010 and all transaction occur in 2010 unless otherwise specified.
a. In late September, Foxworthy signed a $3,500,000 contract with Hawthorn, Inc. for production and installation of custom machinery at Hawthorn's plant. On December 22, Foxworthy shipped Hawthorn the completed machinery, and billed Hawthorn $3,500,000, debiting a receivable and crediting revenue. Foxworthy also debited COGS and credited inventory for $2,550,000, the cost of producing the machinery. The machinery is of no use to Hawthorn without installation and calibration by Foxworthy employees. This work had not been begun as of December 31.
b. In August, Foxworthy signed a lease on an office building to be used for administrative (not manufacturing) purposes. An advance rent payment of $1,000,000 was made and debited to Prepaid Rent. The controller forgot to make the year-end adjusting entry to record the expiration of $450,000 of this prepayment during 2010.
c. In December, Foxworthy shipped goods on consignment to a dealer, booking revenue and an account receivable of $350,000 and cost of goods sold of $235,000. None of these goods had actually been sold to customers by year-end.
d. Two years ago, Foxworthy acquired another manufacturing company whose operations have been integrated with Foxworthy's. The acquisition price included $5,000,000 for goodwill, which has not been amortized. An appraiser with expertise in this industry estimates that the goodwill has lost 45% of its original value due to changes in the industry. Foxworthy's management disregarded this appraisal in preparing the financial statements.
e. Foxworthy sells its products with a one-year warranty. Estimated cost of servicing warranties on products sold in 2010 is $893,000. During the year, Foxworthy actually incurred warranty service costs of $842,000, of which half related to products sold in 2010 and half to those sold in 2009. Foxworthy's accountant charged the actual costs of $842,000 to product warranty expense, and made no other entries to that account.
Required: For 2010, Foxworthy reported operating income (before interest and taxes) of $20,000,000. Compute the correct amount of operating income/loss, showing any necessary calculations and explaining your reasoning.
This solution discusses various accounting errors, how they should be treated, and their impact on the current year's income or loss.