It is the end of 2014, and the auditing firm for which you work is auditing the Weiss Company for the first time. Prior to 2014, Weiss was audited by another firm. A substantial amount of Weiss Company's revenues for 2013 came from installment sales.
Weiss has considerable property, plant, and equipment. It also has a large amount of debt outstanding, and one of the debt covenants is that the company maintain a 2.00 current ratio.
You have been reviewing the deferred taxes of Weiss at the end of 2014. On its preliminary ending balance sheet for 2014, Weiss has included a noncurrent deferred tax liability of $45,000. On its ending 2013 balance sheet, Weiss had also reported a noncurrent deferred tax liability. Upon examining the calculations supporting the $45,000, you find that one-third relates to the receivables from the installment sales and two-thirds relates to the depreciation on the property, plant, and equipment. Nearly all of the 2013 deferred tax liability related to the latter.
Based on your analysis, you raise the issue with Weiss Company's controller about the possibility of reclassifying $15,000 of the deferred taxes as a current liability. The controller responds, "We have always listed our deferred taxes as a noncurrent liability. This was okay with our previous auditor.
It just isn't worth the hassle of splitting the amount into current and noncurrent portions. It is clearly not material, since our total equity is over $400,000. Besides, if we did that it would bring our current ratio down to 1.95 and we would have our creditors on our backs. Everyone knows that deferred taxes are never really paid, so that is a good reason for not including the amount in our current liabilities."
From financial reporting and ethical perspectives, prepare a response to Weiss Company's controller.
The reclassification is needed for several reasons, both from auditing standards, generally accepted accounting standards, and ethical standards of both the AICPA (for CPAs) and the IMA (for management accountants which includes controllers).
I understand that the amount of $15,000 seems small to you but qualitatively, it is large. That is, materiality is not defined as a certain dollar amount but an amount that would change a reader's decision. In this case, the amount would change the bank's view of the current ratio and therefore, it is by definition, "material." So, the argument to not reclassify based on the size of the reclassification is not valid.
Second, the generally accepted ...
Your letter is 444 words and gives three main reasons to compete the reclass. This is a draft for you to use as a template for your own thoughts.